Double-Digit Earnings Gains Will Be Tough in Q2: LPL’s White

Financial-sector firms begin announcing their latest quarterly results on Friday

Financial services companies — including Wells Fargo (WFC), JPMorgan (JPM), Citigroup (C) and First Republic Bank (FRC) — start reporting their second-quarter earnings Friday.

More firms will share their latest results \Monday, when Charles Schwab (SCHW) and BlackRock report their second-quarter performance. On Tuesday, Bank of America (BAC), TD Ameritrade (AMTD) and Goldman Sachs (GS) issue their results, followed by Morgan Stanley (MS) on Wednesday.

Analysts are upbeat but not exuberant in terms of their expectations for the overall earnings season. 

“Earnings season is underway … and may be another good one, with double-digit S&P 500 Index earnings growth possible. But getting to double digits will be tougher than it was in the first quarter when S&P 500 earnings increased more than 15% year over year,” explained Burt White, chief investment officer of LPL Financial, in a report this week.

According to White, Thomson’s consensus for Q2 average EPS growth is 8%. “Given the typical 3–4% upside to estimates, growth in the 11–12% range is a reasonable expectation,” the CIO said.

On Friday, Wells Fargo is expected to report flat earnings of $1.01 per share, JPMorgan's earnings could be up $0.04 year over year to $1.59, and Citi's results should be down $0.03 at $1.21, according to industry estimates.

Why the optimism?

First is economic growth, which should come in at 3% for GDP on an annualized basis in the second quarter, up from the 1.4% pace in the first quarter “and providing a solid backdrop for steady revenue and earnings gains (consensus is calling for 4.6% revenue growth in the second quarter),” White explains.

In fact, surveys from the Institute for Supply Management in Q2 are “supportive,” he says.

“Wage growth has risen at a moderate roughly 2.5% pace based on national income data, helping corporate America protect relatively high profit margins. Meanwhile, data overseas has generally reflected improving economic conditions, albeit gradually, in Europe, Japan, and the emerging market economies, a positive for U.S. multinationals,” White pointed out.

He also says earnings estimates have held up “relatively well” over the past few months.

Source: LPL

In Q2, the current EPS estimated growth rate of 8% is just 2% below the estimate of April 1 — compared with a usual 3–4% decline.

“Based on FactSet analysis, this below-average decline is the best in three years. Estimates for the second half of 2017 fell by less than 1% during the second quarter, an encouraging result even though these estimates may still come down a bit more, as they typically do,” the CIO explained.

Many market-watchers are asking if any pro-growth policies advocated by the Trump administration will be put in place before year-end. On this issue, White is cautious.

“We are skeptical at this point, although we could see a several percentage point boost to S&P 500 profits in 2018, if not more, should tax rates be lowered,” he said. In terms of any “policy boost” being embedded in analysts’ expectations, LPL research analysts “believe it to be minimal at this point.”

As for pre-announcements, the ratio of companies pre-announcing negative quarterly results relative to those pre-announcing positive results (1.9) is better than in the year-ago quarter (2.3), the previous quarter (2.4), and the 20-year average (2.7).

This suggests a high percentage of companies might exceed estimates again, according to White. “An impressive 75% of companies exceeded consensus estimates in the first quarter, leading to a 5% overall upside surprise,” he stated.

Headwinds

What’s holding some companies back? A stronger U.S. dollar (up 4% year over year based on average prices in the second quarter 2017 versus 2016), White points out.

Lower inflation means less pricing power and lower revenues for some industries. Plus, a flatter yield curve “impacts financials as the gap between lenders’ cost of funds and lending rates narrows,” he added.

Year over year, oil prices were up in Q2, but the price fell from late May to late June; they ended the quarter about $4 per barrel below where they started.

White says this has added some risk to the energy sector outlook.

“We expect corporate America to fight through these headwinds just fine overall but acknowledge further risk to energy sector estimates — which have fallen in recent months — for the remainder of the year,” he explained.

The energy sector is expected to contribute 2.6% to the consensus 8% earnings growth estimate for the S&P 500, with technology at 2%. The tech sector’s expected earnings growth in the quarter is 11.2%.

As for financials, they are experiencing a drag on net interest margins from the flattening yield curve and “generally sluggish” loan growth.

Still, the financial sector should produce about 8% growth in earnings in the second quarter, a 1.1% contribution to the overall 8% consensus S&P 500 earnings growth figure.

--- Check out Best & Worst BDs for Advisors: J.D. Power — 2017 on ThinkAdvisor.

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