In his latest Weekly Kickstart note published late on Friday, Goldman’s David Kostin correctly notes that with all eyes on two major macro catalysts in recent weeks –the US elections and the potential for imminent vaccine approval – investors had mostly overlooked the 3Q earnings season. According to Kostin, this “lack of focus” was reflected in the unusual price performance of stocks beating on EPS during the recently-concluded earnings season, namely that whereas in the past, stocks that surpass consensus expectations typically outperform the S&P 500 by 100bps the trading day after reporting, this quarter those firms outperformed by just 9bp, the smallest in our 15-year history outside of 2Q 2017.
Incidentally, a few weeks earlier Bank of America put its own spin on this phenomenon, writing that the lack of upside which is due to stocks being priced to perfection, “smacks of the Tech Bubble, which was the only earnings season in history when surprises saw perverse rather than intuitive reactions – beats were not rewarded and misses were not penalized.” The bank then ominously warned that “the market cracked after the 2Q earnings season when this happened.”
Whether the Q3 earnings reaction is indicative of a lack of investor focus, of euphoria having been pried-in, or is simply a rehash of the previous bubble top remains to be seen, but one notable point made by Kostin is that “margins, more than sales, were the primary source of upside surprises in 3Q” which suggests that once again companies were drastically cutting back on overhead – read laying off workers aggressively.
Some more points:
- At the start of earnings season, consensus expected S&P 500 sales to fall by 3%, and companies realized growth of -2%.
- Analysts also forecast S&P 500 net profit margins would decline by 220 bp to 8.7%, but margins actually fell by much less than expected; net margins contracted by just 83 bp to 10.1%.
- At the sector level, the divergence that occurred in 2Q continued into 3Q. Health Care and Info Tech delivered positiveEPS growth in the quarter (+7% and +5%), while Energy and Industrials saw EPS fall by 109% and 50%, respectively.
- Most notably, limited reserve builds moderated the decline in Financials EPS in 3Q (-7% y/y vs.