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Strategic Insights

Volume 7, Edition 39 | November 5 - November 9, 2018

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Earnings Conundrum

Doug_Walters Doug Walters | Articles

Read Time: 5:00 min

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With the Q3 corporate earnings season coming to an end, we explain the curious phenomenon of strong quarterly earnings being met negatively by investors (and vice versa)…

Market Review

Contributed by Doug Walters

U.S. stocks followed last week’s playbook, with a rally that was muted by Friday weakness. Shares are up over 4% these past two weeks, with investors perhaps happy to have the election uncertainty in the rear-view mirror (albeit temporarily). With the corporate earnings season coming to an end, we explain a common conundrum.

I See Earnings in Your Future

Every corporate earnings season, we see companies miss earnings expectations, yet the shares go up. Likewise, we see companies beat expectations, only to watch their shares get pummeled. There are two such cases in our Strategy Update.  But why this mismatch?

In general, analysts are looking at two things: how were earnings this quarter, and what are they telling us about the future (often referred to as “guidance”). For stocks, the future is much more important than the present. The price an investor is willing to pay for a stock is based in part on the value of all future cash generation. That is not to say their earnings over the last quarter are not important; they are. But the stream of future earnings is much more important!

So, the next time you are at a cocktail party and someone says, “did you see Apple earnings beat by 10%?”, you can follow with, “yeah, but how was their guidance?”

25%

Q3 Earnings are up 25% compared to the same quarter last year.

Strategy Update

Contributed by Max Berkovich , Aleksey Marchenko

STRATEGIC ASSET ALLOCATION

Tally Up

U.S. equity markets advanced higher for the second week in a row, especially on post-election Wednesday. Value stocks advanced the most, while growth stocks continue to trail. Bonds saw some gyration as short and long-term yields advanced higher. Emerging markets and gold were the biggest laggards for the week. As earnings season winds down, we wanted to tally the results…

  • Over 90% of S&P 500 companies have reported earnings so far.
  • Sectors that reported the biggest beat on earnings were Energy, Communication Services, Consumer Discretionary, and Information Technology.
  • Sectors that missed consensus expectations materially were Materials and Industrials.
  • Aggregate earnings growth for the third quarter so far is roughly 25% higher than the same quarter last year.
  • Financials and Energy were the biggest contributors to overall earnings growth, accounting for more than 1/3 of the S&P 500 earnings growth.

STRATEGIC GROWTH

Reservations

Consumer Staples outdueled the Industrials sector for the lead this week. Technology was the laggard as earnings reports from several chipmakers failed to impress investors thanks to conservative (soft) guidance. Speaking of guidance…

  • Booking Holding Inc. (BKNG) reported a quarter that failed to meet consensus expectations, but gross bookings growth of 11.5% and guidance of low double-digit growth in the next quarter helped investors overcome their reservations. The company sited that hotel nights rose over 13% in the quarter and airline tickets rose better than 9%. The one negative is that growth in merchant revenue is at a lower margin than agency revenue.

STRATEGIC EQUITY INCOME

Assurance of Insurance

The Energy sector was the notable laggard this week thanks to crude prices moving below $60. Consumer Staples was boosted to the lead, but mostly because of a holding that could just as easily be classified as Health Care, that being…

  • CVS Health Corp. (CVS) reported a mostly in-line quarter but received a welcomed boost from guidance on the merger with health insurer Aetna (AET). The company expects the deal to close by Thanksgiving. The Wall Street Journal’s Heard on the Street column claims that expectations for this merger are so low that if the deal ends up working, investors will be rewarded.

The Week Ahead

Contributed by Aleksey Marchenko

Take a Moment to Honor the VETS

Veterans Day will be observed on Monday, November 12th.

  • U.S. stock markets will be open, but banks and bond markets will be closed.
  • Strategic will be open.

Earnings from Cisco Systems (CSCO) and Williams-Sonoma (WSM) in our Equity Income strategy will be reported on Wednesday and Thursday after market hours.

  • Cisco Systems, according to Zacks Equity Research, is expected to report 18% year-over-year earnings growth and a 6% jump in revenue for the year.
  • William-Sonoma is also expected by Zacks to have double-digit earnings growth and 5% revenue growth year-over-year.

Trade data in the form of the Import/Export Prices Index, as well as the Consumer Price Index (CPI), Retail Sales, Industrial Production, and several Federal Reserve District surveys (Empire State, Philadelphia Fed, and Kansas City Fed Manufacturing Index), are on the calendar.

Singles Day in China will be “celebrated” this Sunday, November 11th.

  • This one-day shopping event in China grew from a few million to $25 billion in sales in ten years. This shopping event is similar to Black Friday, Cyber Monday, and Amazon’s Prime Day.
Indices & Price ReturnsWeek (%)Year (%)
S&P 500 2.14.0
S&P 400 (Mid Cap)1.1-0.9
Russell 2000 (Small Cap)0.10.9
MSCI EAFE (Developed International)1.1-9.5
MSCI Emerging Markets-0.3-14.2
S&P GSCI (Commodities)-1.60.2
Gold-1.9-7.4
MSCI U.S. REIT Index3.5-1.3
Barclays Int Govt Credit0.1-2.9
Barclays US TIPS0.3-4.8

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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