Sunday, August 28, 2016

Q2 Earnings Review

We at YRI have updated all of our chart publications that track S&P 500 revenues, earnings, and margins with Q2 data. S&P compiles both revenues and reported (unadjusted GAAP) earnings for the S&P 500. The latter peaked at a record high of $27.47 per share during Q3-2014. It then fell 31.9% through Q4-2015. That five-quarter earnings recession coincided with the collapse in oil prices and in the S&P 500 Energy sector’s earnings.

Reported earnings rebounded 24.7% during the first two quarters of this year as the price of a barrel of Brent crude oil rose 33% during the first half of this year, suggesting that the Energy-led earnings recession is over. That’s confirmed by S&P 500 revenues, which was negative on a year-over-year basis from Q1-2015 through Q4-2015, falling by as much as 3.8% y/y during Q2-2015. During Q1 and Q2 of this year, this growth rate was 0.3% and 1.1%. So far, I can’t find too many devils in the details:

(1) Revenues. On an aggregate basis, rather than per-share, revenues growth remained slightly negative during Q2 for the sixth consecutive quarter, at -0.7%. This series is highly correlated with and often identical to the yearly percent change in manufacturing and trade sales, which was down 0.6% during Q2.

One can exclude Energy earnings from aggregate revenues (not per-share). On this basis, revenues rose 2.2% y/y during Q2. Furthermore, the growth in aggregate S&P 500 revenues excluding Energy remained in positive territory throughout the recent earnings recession. The weakest growth registered during this period was 0.2% during Q4-2015, which probably reflected the knock-on effects of the Energy recession on other sectors as well as the significant appreciation of the dollar.

(2) Earnings. Before turning to S&P 500 earnings per share, let’s follow our discussion of aggregate revenues with a discussion of aggregate earnings. The complication is that there are three aggregate measures of earnings that we at YRI track. They are earnings as reported by companies and operating earnings as compiled separately and differently by S&P and Thomson Reuters (TR). S&P derives its measure of operating earnings by excluding items that S&P deems to be non-recurring ones. TR’s composite is based on the operating estimates provided by industry analysts, who tend to be guided by company managements.

I favor the TR approach because I believe that the market reflects the estimates of industry analysts while recognizing their optimistic bias. Again, focusing on the aggregates, I find that TR earnings rose to $254 billion during Q2, only 6.1% below the record high in Q4-2014. Excluding Energy, TR’s aggregate earnings is back at last year’s record high after a brief dip during Q1.

The story is more or less the same for the S&P aggregate operating earnings composite. The bottom line is that excluding Energy, it has been a growth recession rather than an outright recession for earnings.

One can’t do the same kind of analysis for earnings on a per-share basis. In other words, I can’t show you this measure without Energy. However, the TR measure of total S&P 500 operating earnings per share didn’t fall much since mid-2014. It rebounded during Q2 to $29.31 per share, only 4.0% below the record high of $30.54 during Q4-2014.

(3) Margins. Calculating the S&P 500 profit margin using the TR data for earnings per share and the S&P data for revenues per share, I can report that it edged back up to 10.3% during Q2. In other words, it continues to hover in record-high territory around 10%, as it has been since Q1-2014. So far, it has refused to revert back to the proverbial mean, as widely expected by the bears.

(4) Forward aggregates. I track forward earnings, forward revenues, and the implied forward profit margin on a weekly basis; these tend to be good leading indicators of their respective quarterly series. All three have remained relatively flat in record-high territory since mid-2014. Forward earnings and forward revenues seem to be on the verge of achieving new highs. (See our S&P vs. Thomson Reuters.)

During the week of August 11, forward earnings was $127.99 per share. That’s a time-weighted average of analysts’ latest estimate for this year ($117.86) and next year ($134.42). I am using $119 for this year and $129 for next year. I raised my S&P 500 target for next year from 2200-2300 to 2300-2400 on July 20. So far so good, especially if the market is agreeing with me that the earnings recession wasn’t much of a recession and that it is over, in any case.

(5) Leading indicators. By the way, S&P 500 forward earnings isn’t one of the 10 components of the Index of Leading Economic Indicators (LEI), but perhaps it should be. It is highly correlated with the LEI. It tends to lead the Index of Coincident Economic Indicators (CEI). July’s LEI was within 1.3% of the record high during March 2006, while the CEI rose to a new record high last month. There’s certainly no recession in either of these economic indicators.

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