All Downhill From Here? Market Refuses To Reward Earnings Beats, Punishes Misses

With the bulk of earnings season now behind us, one chart summarizes best the unprecedented divergence in surging EPS actual vs consensus:

Some more details on what has transpired so far, courtesy of BofA: as of Week 4, 409 companies, or 87% of S&P 500 1Q earnings, have reported. The remainder (chiefly Retailers/Tech) will be spread out over the rest of May/June, after which we’ll issue a final update.

Bottom-up EPS surged to $37.98 from $37.53 last week (led by Energy), now 5% above analysts’ expectations at the start of earnings season (biggest beat in three years) and 4% above our forecast.

In case it’s not clear, it has been an avalanche: all 11 sectors have seen earnings beat, led by Tech, Financials and Industrials, with 72% of companies beating on EPS, 73% on sales and 57% on both – the highest proportion of EPS and sales beats in BofA data history (since 2000). Digging deeper, tech saw the most beats on both (87%, a record high), followed by Health Care and Industrials (71% and 63%, both near-record highs).

With Q1 2018 earnings growth tracking +23% YoY – the best in 7+ years – BofA contends that this is more than just lower taxes, as the beat in pre-tax profits is tracking 3%, and growth in pre-tax profits is a healthy +13% YoY (suggesting ~10ppt of earnings growth is from tax reform). And sales are tracking +8% YoY (+9% ex-Financials), more than 1% above analysts’ expectations at the start of April (and nearly 4x the size of the average sales surprise in our data history since late 2011.

However, these amazing stats have not been sufficient, and the S&P continues to be flat for the year despite the best earnings season in 7 years. One reason, perhaps the biggest one as we discussed last night, is that according to various indicators, this is as good as it will get for earnings, and whether due to margin pressures, or contracting P/E multiples, it’s all downhill from here.

That also explains a striking observation: the market has not rewarded earnings beats this quarter, while severely punishing earnings misses.

As BofA summarizes, EPS and sales beats outperformed by 0.5ppt the next day, the third time in the last four quarters we’ve seen a sub-1ppt reward for beats, a late-cycle phenomenon. Meanwhile, misses have been slammed, lagging the market by 1.5ppt

Putting this divergence in context, since 2000, beats/misses have outperformed/ underperformed by 1.6ppt/2.4ppt the next day.

And while most sectors have seen a muted reward for beats, beats have outperformed most within Telecom and Real Estate. Conversely, misses have been punished the most in Staples, Telecom and Health Care.

To summarize: yet another confirmation it is so late in the cycle, the market itself no longer believes these fantastic earnings can continue for more than one or two quarters at the most…


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