This Is What To Expect From The 1st Quarter Earnings Season

The First Quarter Is Not Going To Be Pretty

The first-quarter earnings cycle is just around the quarter and I am here to tell you it’s not going to be pretty. The first shocks of the coronavirus pandemic were felt early in the quarter and threaten to shave double-digits off the S&P 500’s (SPY) EPS for the quarter. Investors should expect lots of bad headlines but don’t let them cloud the big picture.

How Bad Will The Q1 Results Be?

The consensus estimate for the 1st quarter had been falling steadily since well before the virus threat emerged. When it did, the consensus for the quarter went straight into the toilet. Since then, the average estimate has fallen 1000 basis points putting consensus firmly in negative territory. If the season ends as bad as it looks, Q1 growth near -7.5%, it will be the worst quarter for earnings shrinkage in many decades.

The question I have is how the index will perform relative to consensus. Historically, the S&P tends to outperform the analyst’s consensus estimate by about 5%. This means the market may be expecting the results to be better than currently forecast and there is risk in that. The full impact of the coronavirus on business is still an unknown which means average S&P 500 companies could report weaker than expected figures for the quarter.

Oh, But The Second Quarter Will Be Worse

As important as the first quarter figures will be, they are already old news, we just haven’t heard them yet. The figures that will really move the market is the guidance for the 2nd quarter and the full-year. As it stands now, the 2nd quarter will be far worse in terms of earnings growth if the analyst’s consensus is correct.

Over the past two months, the consensus for S&P 500 EPS growth fell 2100 basis points to just shy of -15.0%. At this level, we can be assured the index will post a negative quarter of growth and set a new record if one isn’t set in the first quarter.

What the market will be searching for in the guidance is confirmation of these figures and the risk is twofold. On the one hand, guidance could fall short and undermine consensus. On the other, the guidance could be more optimistic than expected and spur a round of upward revisions for the broad market.

The Outlook Is Good, Despite How Bad It Is

While the near-term outlook for EPS growth is dismal the news is not all bad. The next two reporting cycles are going to be hard, we are going to see EPS contract over the first half of the year, but a rebound is expected to start as early as the third quarter. The trajectory of EPS growth is positive from that point forward and has two tailwinds to support it.

The first tailwind is that EPS growth is expected to improve in the 3rd quarter and accelerate through calendar 2021. The second is that the analyst’s estimates for 2021 continue to rise. Both figures suggest the S&P will be more valuable in the future than it is now. In my view, the only thing missing for a sustained rally to form is outperformance in the Q1 results and better than expected guidance.

There’s Something You Should Know About The Energy Sector

What you need to know about the energy sector (XLE) is this: the energy sector is impacting the Q1, FY 2020 and FY 2021 consensus figures more than any other sector. The oil price war and oversupply, more than anything else, is to blame. With WTI trading at its lowest levels in decades, there is little hope for profits and much less for earnings growth.

The consensus for earnings growth in the 1st quarter for the Energy sector is just under -40%. The consensus for calendar 2020 is negative EPS growth in the range of -76%, more than four times the contraction of the next worst affected sector. Factoring this out of the equation, S&P 500 EPS growth will be positive for the 1st quarter and the year.

The Tipping Point, It May Have Already Been Reached

The tipping point, the bullish tipping point, for equity markets will be when the outlook for the 3rd and 4th quarter EPS growth stabilizes and/or begins to improve. This tipping point is tied to the coronavirus and its peak, and we may already have crossed it. China and South Korea are getting back to normal; Italy, Spain and the EU have their peak: Germany is forming a plan for reopening: and even here in the U.S. there is evidence the spread has slowed at the national level.

In another month, well before the end of the first-quarter reporting cycle, the news could be even better. Perhaps better enough that we’ll start seeing the consensus figures for 2Q, 3Q, 4Q and full-year 2020 begin to improve and when that happens the rally will be on. As I’ve said before, the optimal conditions I can think of for market rallies is when EPS outlook is positive, the trajectory of growth is accelerating, and the estimates are rising. In that environment, I see no reason why the S&P 500 can’t retest its all-time highs by the end of the year.