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Clouds on the Earnings Horizon

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Unlike the last few quarters when the earnings picture remained unequivocally positive and reassuring, we may be starting to see some clouds emerge on the horizon as look ahead to the start of the Q3 earnings season.

The ‘clouds’ refer to the trend of rising costs and supply-chain issues that have been a recurring theme in recent quarterly reports or pre-announcements from the likes FedEx (FDX - Free Report) , Nike (NKE - Free Report) , Bed, Bath & Beyond (BBBY - Free Report) and others. We also have to contend with the negative impact of the Delta variant which has been showing up in macroeconomic and corporate data.

Some of this has showed up in the revisions trend that has reversed course over the last two months after consistently remaining positive over the past year. You can see this in the chart below that tracks the evolution of Q3 earnings growth expectations.

Zacks Investment ResearchImage Source: Zacks Investment Research

What we see here is that the trend appears to have shifted course over the last few weeks after remaining modestly positively since the start of the quarter.

This loss of momentum is likely tied to the emerging economic slowdown, which in turn is likely a function of the Delta variant. We also need to keep an eye on the margins outlook given rising cost trends in labor, inputs, freight/logistics and other line items.

The market appears to agree with the Fed’s assessment of this trend as ‘transitory’ and a function of Covid-related disruptions that eventually even out. This view is reflected in current consensus estimates, as you can see in the chart below.

Zacks Investment ResearchImage Source: Zacks Investment Research

This ‘transitory’ view of the ongoing cost pressures is even more pronounced in the annual view of the margins picture, as the chart below shows.

Zacks Investment ResearchImage Source: Zacks Investment Research

We all know that the ‘transitory’ or otherwise debate has implications for Fed policy, which is as important for the market as the outlook for earnings and margins.

To bring the conversation back to the revisions trend, it is important to point out that estimates for 2021 Q4 have nudged up in recent weeks even as the same for 2021 Q3 have stalled out.

Expectations for Q3 & Beyond

The last earnings season (2021 Q2) not only witnessed a very high earnings growth rate, but the aggregate tally of total earnings also reached a new all-time quarterly record, surpassing the record set in the preceding period. Other positives that came out of the Q2 earnings season included the breadth of strength across all the key sectors and the notable momentum on the revenue front.

We know that the unusually high growth rates of the first two quarters of the year will not continue in the last two quarters, as they largely reflected easy comparisons to the year-earlier periods that were severely impacted by Covid-related disruptions. Comparisons will be relatively normal in 2021 Q3 and beyond as the U.S. economy had started opening up in the year-earlier period and hence the expected deceleration in the growth pace.

You can see this expected growth deceleration in the below chart that puts 2021 Q3 earnings and revenue growth expectations in the context of where growth has been in the preceding four periods and the estimates for the following three quarters.

Zacks Investment ResearchImage Source: Zacks Investment Research

The comparable picture on an annual basis is no less impressive, as you can see in the chart below.

Zacks Investment ResearchImage Source: Zacks Investment Research

We mentioned earlier how the aggregate 2021 Q2 earnings tally represented a new all-time quarterly record. You can see that in the chart below, with this year’s four quarters highlighted.

Zacks Investment ResearchImage Source: Zacks Investment Research

We all know that large segments of the economy, particularly in the broader leisure, travel and hospitality spaces are held down by the pandemic, with companies in these areas still earning significantly less than they did in the pre-Covid period. In fact, many of these companies aren’t expected to get back to pre-Covid profitability levels for almost one more year.

The impressive feature of the record earnings in each of the last two quarters is that they were achieved without help from these key parts of the economy.

Earnings Season Gets Underway

Most companies have fiscal quarters that correspond with the calendar periods. As such, the wide majority of Q3 earnings reports will be from companies that have fiscal quarters ending in September. But there are some companies that have fiscal quarters ending in August and a number of them have been reporting their fiscal August-quarter results in recent days.

The earnings releases in recent days from the likes of FedEx (FDX - Free Report) , Oracle (ORCL - Free Report) , Adobe (ADBE - Free Report) , Nike (NKE - Free Report) and others all fall in this category; they all had fiscal quarters ending in August. We count all of these reports as part of our Q3 earnings tally.

Through Friday, October 1st, we have seen such Q3 results from 17 S&P 500 members, with another 4 index members on deck to report results this week. These include operators such as Pepsi (PEP - Free Report) , Constellation (STZ - Free Report) and others that will be releasing their fiscal August quarter results this week.

By the time JPMorgan (JPM - Free Report) and other big banks start rereporting their September-quarter results on October 13th, we will have seen such August-quarter results from almost two dozen S&P 500 members.

For the 17 index members that have reported Q3 results already, total earnings are up +26.3% from the same period last year on +18.3% higher revenues, with 82.4% beating EPS estimates and 58.8% beating revenue estimates. The proportion of these 17 index members beating both EPS and revenue estimates is 47.1%.

This is too early and the sample size is too small to offer us any interpretive guidance, but the very strong momentum on the revenue side that was a notable feature of the Q2 earnings season doesn’t appear to be present at this admittedly early stage.

Zacks Investment ResearchImage Source: Zacks Investment Research

For a detailed look at the overall earnings picture, including expectations for the coming periods, please check out our weekly Earnings Trends report >>>>Previewing the Q3 Earnings Season