US earnings deliver lots of sparkle but no pop

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US & Canadian companies updates

US corporate earnings have been staggeringly strong this season, defying concerns about the economic impact of a rise in Covid-19 cases. 

With four-fifths of S&P 500 companies having reported second-quarter results, a record 86 per cent have exceeded expectations on profits, according to data from S&P Global. 

Technology, healthcare and consumer discretionary groups have led the pack, with more than 90 per cent of the sectors’ reporting companies posting profits that beat expectations. 

Operating margins hit 13.1 per cent in the second quarter, surpassing the record set in the first three months of the year as companies trimmed costs and sales rebounded from their falls in 2020. Margins were largely boosted by banks, which began to release money they had set aside to cover potential losses triggered by the pandemic. 

However, the positive news has not resulted in huge share gains.

Q2 earnings beats and misses

Apple reported earnings of $1.30 per share, exceeding expectations by 28 per cent. But the following day its stock slipped by more than 1 per cent. Consensus-beating profits for Microsoft and Alphabet led to only modest share gains, with Alphabet rising 3 per cent and Microsoft’s stock barely budging. 

S&P 500 companies that topped earnings expectations have outperformed the market by only 10 basis points on a median basis, while earnings misses underperformed the index by 1 per cent, according to research by UBS. 

In the previous quarter, companies that beat expectations outperformed the S&P 500 by 35bp, while the long-run average from 2011 to 2019 is about 66bp. 

Buoyant markets in the run-up to reporting season may be a factor. The S&P 500 has risen more than 30 per cent over the past year and remains near its all-time highs, helped by monetary policy and low interest rates. Many tech stocks have hit records in recent weeks, including Apple, Microsoft and Alphabet.

But Keith Parker, head of US and global equity strategy at UBS, believes there is more to the muted gains than the market’s lofty levels. He says a lack of upgrades to forward earnings estimates for the coming quarters could be holding share prices back. 

“We’ve seen big beats, with Q2 earnings exceeding consensus estimates by nearly 20 per cent, but there have not been similar revisions in forward earnings for Q3 and Q4, which are up only 4 per cent and 3 per cent since the start of the current earnings season,” Parker said. 

Line chart of Estimates earnings per share ($) showing Earnings revisions zoom for Q2 2021 but not for the following quarters

Investors may not view this season’s earnings growth as sustainable, which would underscore why companies beating expectations have not been rewarded by the market. 

And record aggregate operating margins may not last long. Companies have been able to pass on higher costs from a rebound in consumer spending as the economy reopens but in future this is likely to be more difficult.

Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, also questions whether the season’s strong cash flows and record margins can be maintained.

“At some point, increased spending and investment as well as price resistance will take the margins down, which may be positive economically but equity prices may not agree,” he said.

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