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Stronger-than-expected Q3 earnings receive lackluster reaction

by | Nov 4, 2020 | Weekly chart review

With the Q3 2020 earnings season competing directly with the election season and the global uptick in COVID-19 cases, the reaction to unexpectedly stronger earnings has been disappointing.

First, the Q3 earnings analysis so far from FactSet (as of Oct. 30):

“At this point in time, the percentage of S&P 500 companies beating EPS estimates for the third quarter and the magnitude of the earnings beats are at or near record levels. … Despite the increase in earnings, the index is still reporting the third largest year-over-year decline in earnings since Q3 2009, mainly due to the negative impact of COVID-19 on a number of industries within the index. …

“Overall, 64% of the companies in the S&P 500 have reported actual results for Q3 2020 to date. Of these companies, 86% have reported actual EPS above estimates, which is well above the five-year average of 73%. … In aggregate, these companies are reporting earnings that are 19.3% above the estimates, which is also well above the five-year average of 5.6%.”

FIGURE 1: S&P 500 EARNINGS ABOVE, IN-LINE, AND BELOW ESTIMATES (Q3 2020)

Source: FactSet

Key highlights:
  • Despite the number of earnings “beats” previously described, FactSet reports a year-over-year decline in earnings of -9.8% in aggregate so far, much better than initial expectations but still the “third largest year-over-year decline in earnings reported by the index since Q3 2009” and “the sixth time in the past seven quarters in which the index has reported a year-over-year decline in earnings.”
  • The Health Care, Consumer Staples, Information Technologies, and Utilities sectors are showing positive year-over-year earnings, while seven major sectors are showing declines. The heaviest year-over-year declines are found in the Energy, Industrials, and Consumer Discretionary sectors.
  • 81% of S&P 500 reporting companies have delivered actual revenues above estimates, which is above the five-year average of 61%.
  • S&P 500 companies are reporting a year-over-year decline in revenues of 2.1%.
  • Five sectors have reported year-over-year revenue growth, led by the Health Care sector. Six sectors, led by Energy and Industrials, have a Q3 year-over-year decline in revenues.
  • Looking forward, FactSet reports that “analysts predict a (year-over-year) decline in earnings in the fourth quarter (-11.2%) of 2020. However, they are also projecting a return to earnings growth starting in Q1 2021 (14.5%).”

FIGURE 2: S&P 500 REVENUE GROWTH (Q3 2020)

Source: FactSet

Bespoke Investment Group notes that the market environment for companies reporting earnings last week was hardly favorable:

“Talk about a Halloween scare. In a week where the S&P 500 has historically risen 1%, it traded down more than 5% which was its worst one-week performance since the COVID crisis. Even more notable was the fact that it was the worst performance for the S&P 500 in the last full week before a Presidential election on record. At the close on Friday, the S&P 500’s week-to-date decline was nearly twice the decline of the second-worst week in 1932 when the S&P dropped 2.96% in the last full week leading up to the 1932 election of FDR!”
Bespoke adds,
“Earnings season has been an enigma as results have been extremely strong, but reactions have been weak. This could be a sign of deeper trouble, but it also reflects the fact that expectations were extremely high heading into the reporting period, so a sell the news reaction isn’t surprising.”

See Related Article: Is the market’s lofty valuation justified in the middle of a pandemic?

Bespoke reports that while the earnings reports so far might have led one to expect a market rally and generally strong share price increases for those companies reporting results, that has not been the case. They cite a number of reasons, in addition to “high expectations”: election uncertainty, COVID case upticks (especially in Europe), the lack of government stimulus, the possibility for further U.S. lockdowns, and the potential for recent gains in the economy slowing down:
“Companies reporting earnings over the last three months have essentially traded unchanged (+0.02%) in reaction to their reports. Not exactly the type of reaction you would expect to see from record EPS beat rates and a record percentage of companies raising guidance.”
Additionally, Bespoke notes that markets are not rewarding companies with earnings beats, with “the average gain on an EPS beat … just 62 bps [basis points] this quarter, the weakest for the cohort of companies reported so far since the reporting period of Q4 2009 results.” Additionally, companies issuing guidance, but not raising it, have been penalized with an average stock share price decline of more than 1.3%.

FIGURE 3: EARNINGS BEATS ARE ONLY GETTING A MODEST BENEFIT

Source: Bespoke Investment Group

FIGURE 4: HISTORICALLY LOW BENEFITS TO GUIDANCE RAISES OR IN-LINE GUIDANCE

Source: Bespoke Investment Group

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