We are a few weeks away from the start of the 2013 Q3 earnings season, with estimates for the quarter down sharply from where they stood just a few months back. This isn’t unusual as we have been seeing this negative revisions pattern play out repeatedly in recent quarters. Estimates for the following quarters (Q4 and beyond) have held up fairly well, likely indicating that analysts expect the earnings picture to improve materially going forward.
We didn’t see any evidence in the Q2 earnings season that would inspire such confidence in the overall earnings picture. Yes, total earnings reached a new quarterly record in Q2 and other aggregate metrics like growth rates and beat ratios looked respectable as well. But all of that was solely due to one sector only: Finance. Exclude Finance from the aggregate numbers and the picture that emerged was anything but satisfactory.
But before we start referring to the 2013 Q2 earnings season in the past tense, let’s acknowledge that it hasn’t technically ended yet. As of today, we still have Q2 results awaited from a couple of S&P 500 members. But total earnings for the 498 S&P 500 companies that have reported are up +2.5% from the same period last year, with 62.7% beating earnings expectations with a median surprise of +2.9%. Most of that earnings growth has come from top-line gains (up +1.9%), with margins essentially flat from the same period last year. Revenue surprises have been better relative to the extremely weak levels in Q1, but largely in-line with historical levels.
Finance is solely responsible for keeping aggregate earnings growth for the S&P 500 in the positive column. Excluding Finance, total earnings growth in Q2 was negative. While earnings strength was concentrated in Finance only, the weakness was broad-based. From Technology to Basic Materials and Industrials to Retail, all contributed to the weak earnings picture.
The Retail sector was expected to do better, but early results from leaders like Macy’s (M) and Wal-Mart (WMT) had given us a pretty good preview of what transpired. The Retail sector’s Q2 earnings and revenue growth numbers were actually decent enough. But surprises were predominantly negative and guidance was very underwhelming.
Expectations for Q3 have come down materially as the Q2 reporting season unfolded and companies guided lower. The chart below plots how Q3 consensus earnings growth estimates for the S&P 500 have evolved over time. 
The negative revisions to Q3 estimates have been very pronounced in a few sectors, namely Retail, Basic Materials, Industrials, Consumer Discretionary, and Technology. Current total earnings growth for the Retail sector in Q3 is less than a quarter of what was expected in early May, while Basic Material’s expected has dropped to less than a third over the same time period.
Unlike the downtrend in Q3 estimates over the recent past, expectations for Q4 and beyond have held up fairly well and still represent a material acceleration in the growth pace. The chart below shows growth expectations for Q3 and Q4 and what was actually achieved in the last few quarters.
A lot of the Q4 growth is expected to come from sectors outside of Finance, as the chart below of ex-Finance growth expectations shows. Even the expected flat finish in Q3 is a material improvement from what we saw in Q2.
Most of the recent negative Q3 estimate revisions have been in the sectors outside of Finance. Current ex-Finance Q3 growth estimate is less than a third of what was expected a few weeks back. But given what we have seen from these sectors in Q2 thus far, it seems like a tall order for this level of growth ramp up. My sense is that estimates need to come down further, particularly for Q4.
The market hasn’t cared much in the recent past about negative revisions as aggregate earnings estimates have been coming down for over a year now. But if we are entering a post-QE world, as I believe we are, then it will likely be difficult to overlook negative earnings estimate revisions going forward. How the market responds to negative guidance and the resulting negative revisions will tell us a lot about what to expect going forward.
Key Points
- Total earnings for the 498 S&P 500 companies that have reported results are up +2.5%, with 62.7% beating earnings expectations. Revenues for these companies are up +1.9%, with a revenue ‘beat ratio’ of 50.2%.
- The earnings and revenue growth rates are roughly in-line what this same group of companies reported in recent quarters, while the revenue beat ratios have been better relative to Q1’s extremely low rate.
- Finance results have been very strong, with total earnings for the companies that have reported results up an impressive +30%. Excluding Finance, total earnings for the remainder of S&P 500 companies that have reported would be down -2.9% from the year-earlier period.
- Finance reclaims its leadership role in the S&P 500, contributing more earnings to the index’s total than Technology this year for the first time since the 2008 crisis. The sector is expected to account for 19.7% of total S&P 500 earnings in 2013 compared to Technology’s 17.9%.
- Technology earnings remain weak, with total earnings for the sector down -10.1% on +0.4% higher revenues. Margins have been under pressure across the board for many industry players like Apple (AAPL), Google (GOOG), IBM (IBM), and others.
- Technology remains a big drag on earnings growth in Q2. Excluding Technology (but including Finance), total Q2 earnings for the S&P 500 would be up +5.4%.
- Estimates for 2013 Q3 have started coming down, with current Q3 total earnings growth of +2.3% down from +5.2% in early July. But expectations for the fourth quarter (up +11.7%) still represent a material growth ramp up from the first half’s level.
- While there is not much growth, the overall level of total earnings is quite high, with total earnings in Q2 on track to surpass Q1’s all-time quarterly record. Earnings for the S&P 500 companies are expected to total $255.9 billion in Q2, a new quarterly record.