What To Expect From The Q4 Earnings Cycle

It’s Time To Get Ready For Q4 2021 Earnings

With the S&P 500 NYSEARCA: SPY Q4 earnings cycle having already started, it is time to get ready for the peak of the season. The peak is still quite a few weeks away but it pays to be ready. So far, reports from names like Oracle NYSE: ORCL and Broadcom NASDAQ: AVGO suggest a strong quarter of reporting for the tech sector but things might not be so robust for other sectors. In our view, supply chain worries, inventories, and rising inflation are going to be the dominant theme once again, the question is whether the average S&P 500 company will be able to overcome the challenges and by what kind of margin?

The S&P 500 beat the consensus for earnings growth by an average of 3000 basis points during the second half of 2020 and the first half of 2021 but that figure has been coming down. The average S&P 500 company beat by a much smaller 1200 basis point margin in the 3rd quarter and we think it may be even smaller in the 4th. Not only is economic momentum waning but inflation continues to cut into the bottom line for many company’s and there is only so much inflation the consumer can bear. The retail figures already suggest higher prices are cutting into volume and that is a very bad thing for the economy. If higher prices cut into sales, results could be mixed in terms of revenue and earnings expectations. 

Earnings Growth Will Slow In The 4th Quarter 

Earnings growth is slowing from the high 90% pace set in the 2nd quarter of calendar 2021 to only 21.2% in the 4th. Assuming the market beats the consensus by the same margin as in the 3rd quarter that’s still a deceleration of more than 50% which is not a positive for price action. The analyst’s consensus estimate for growth has been trending steadily at this level which is also worth noting because the estimate trended higher going into each of the previous four quarters. We take this as a sign of uncertainty among the analysts and one that opens the door for unexpected events to happen, either a miss or a beat and each could be quite large. Based on the latest inflation data, however, we are leaning toward “weaker than expected” for many sectors including the Consumer Discretionary. 

Looking forward, the outlook is for more of the same. Annualized growth will slow to only 9.0% in 2022, down from over 45% in 2021, with weaker results in the front half of the year. The consensus for earnings growth in Q1 2022 is only 6.0% compared to 21.2% in the 4th and then falls to only 3.9% for Q2 2022. These, like the estimate for Q4 2021, are trending steadily to the side and do not offer much confidence at this time. 

The Sectors With The Highest Growth Expectations Are … 

The sectors with the highest growth expectations in this reporting cycle are Energy, Materials, and Industrials. The Energy sector, in particular, is worth having a stake in simply because of oil prices. Oil prices are down from their recent peak but still, double what they were at the end of last year and trading at 3-year highs so we think the Energy companies are about to report windfall profits. Industrials and Materials are also expected to do well due to economic reopenings, resumption of long-mothballed projects, and general economic activity. 

The Technical Outlook: The S&P Is Ripe For A Correction 

The S&P 500 are ripe for a correction simply because of the valuations. The average company is trading at more than 21X forward earning and well above the 5 and 10-year averages. The catch is that earnings are still growing and the trend is still up so timing a correction may be tricky. It looks like at least a small correction is forming now and if so, it could take the index below the 4,500 mark. In that scenario, the index next target for support is close to the 4,300 level where we would expect to find much stronger support. If the index is able to regain its footing at or above the 4,500 mark, we may see some sideways trading until the peak of the reporting season begins. In either case, we view a pullback in index prices, especially a major correction, as an opportune entry point. Earnings growth is slowing, it’s not disappearing, and the economic outlook is still positive if overshadowed by inflation. 

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