Just keep swimming: what we’ve learnt from Q4 earnings

Over the next few weeks we will once again be bombarded by bottom-up news flow as we head into the meat of the Q4 earnings season. More than half of S&P 500 constituents report in the next three weeks.

It may be early days in this earnings season, but I think the broad patterns are already becoming visible. After all, we’ve had some examples of Q4 results already, and a reasonable number of companies with different quarter ends reported over the past few weeks.

Not great, but not a disaster

Q4 numbers are fine, at least when compared with sell-side analyst estimates.

Around three-quarters of early reporters managed to beat estimates,¹ which is a bit ahead of the historical average. In the proper earnings season, so far only around 60% of companies have managed to beat estimates,² below average but far from disastrous.

This tells us that analyst estimates for current earnings are not unusually far away from reality, so there is no big pressure to cut forecasts from this perspective.

Leaving aside analyst estimates, company earnings growth has largely ground to a halt. Analyst consensus forecasts are for -2% year-on-year earnings-per-share growth for the S&P 500. If we add the typical margin by which companies beat analyst estimates, earnings should come in slightly ahead of the previous year’s level. This is pretty close to what we had pencilled in at this stage on the way into an earnings recession in 2023.

That don’t impress investors much

Another takeaway, though, is that it while it may be easy for companies to beat sell-side analyst estimates, it seems more difficult to impress investors.

Only about half of companies outperformed the market on the day after results, and this has continued so far in the full Q4 reporting season. The difference between the stats on beating analyst estimates and the share price reaction is that the former measures backward-looking earnings, which seem fine, while the latter is more about forward-looking comments like guidance and outlooks, which seem to be weaker.

To some degree this should not come as a surprise. Companies ‘live’ in the same world we do, look at the same data and read the same news. In this environment, it’s very difficult to see the average CEO sounding particularly optimistic about the next year.

Keep dancing

However, as long as current activity holds up like it has so far (see backward-looking Q4 numbers), we should also not expect companies to be particularly bearish in their messaging or even act in a way that assumes recession. As former Citi CEO Chuck Prince said before the financial crisis, “As long as the music is playing, you’ve got to get up and dance.”

Overall, we have seen nothing in this reporting season that changes our view that US earnings will fall 20-25% in the recession that our economists expect to begin in Q2 this year. The real earnings decline, and sharp cuts to analyst forecasts, will only begin once the actual recession begins, not in anticipation.

So, for now, we anticipate an OK reporting season, where most companies beat sell-side analyst estimates, but sound cautious about the outlook, leading to further trimming of analyst earnings estimates.

This expectation informs the modestly negative overall stance on risk assets we have taken within the Asset Allocation team.

1. Source: Bloomberg, as at 19/01/2023

2. Source: ibid.