Macro: Sandcastle economics
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Earnings Watch: Can Q4 earnings swing into growth?
Peter Garnry
Chief Investment Strategist
Summary: The Q4 earnings season was off to a mixed start last week with especially the negative response to earnings from three major US banks on Friday. We maintain our positive view on US banks due to more stimulus and our conviction idea for 2021 being reflation. We also take a look at long-term changes in quarterly earnings and how the equity market has mostly been carried by lower discount rate of future cash flows rather than earnings growth. Finally, we take a look at this week's most important earnings releases.
Last week’s earnings releases were the starter before the main course starts this week. Major US banks reporting on Friday were selling off on back of Q4 earnings leading the broader equity declines into the weekend. As we alluded to in our review of these banking earnings, the market was overly pessimistic on those earnings as the outlook was improving in the banks’ earnings statement and those outlooks are naturally not factoring in the upcoming stimulus checks from the new Biden administration. This stimulus will act as a backstop on credit deterioration and bolster the banks’ balance sheets providing the opportunity throughout 2021 to release income from the loan loss reserve account. That coupled with reflation trades and the rising yield curve will help US banks this year. We maintain our positive view on US banks in 2021.
The Q3 earnings season was the turning point with earnings rebounding strongly from the bottom in Q2 and expectations are that earnings will continue to grow q/q. The new restrictions that were introduced across many European countries as the second wave of Covid-19 accelerated have likely prevented corporate earnings from increasing significantly in Q4, and thus it is difficult to expect earnings growth y/y in Q4. However, Q1 helped by base effects will begin to show earnings growth y/y, but for the next year the q/q changes will be the only indicator on earnings we can rely on as the large base effects will make y/y numbers meaningless. Based on the current earnings that are for Q4, the MSCI World Index EPS in Q4 is down 6% compared to S&P 500 where EPS is down 10% y/y.
Our long-term chart on quarterly earnings show another startling fact. Quarterly earnings so far in Q4 2020 for MSCI World is down 0.2% annualized since Q2 2007 which means that after inflation corporate earnings are negative in real terms over 13 years. Only central bank action lowering the discount rate on future cash flows has supported the bull market in global equities. The annualized growth rate for quarterly earnings is 3% in S&P 500, which means a low positive real rate growth rate in US corporate earnings.
This week’s most important earnings are highlighted below with the ones marked in red being those that are worth watching for macro or equity sentiment reasons. Netflix reports tomorrow with a high bar to climb following its disappointing Q3 earnings. Higher subscription price in the US will help on revenue growth but investors will demand strong numbers on net new subscribers or else the stock will be punished.
- Tuesday: Charles Schwab, Bank of America, Goldman Sachs, State Street, Netflix
- Wednesday: Interactive Brokers, Kinder Morgan, ASML, Fastenal, Morgan Stanley, Discover Financial Services, P&G, UnitedHealth, US Bancorp, Bank of New York Mellon
- Thursday: Gilead Sciences, Sandvik, Investor AB, Fifth Third Bancorp, Intel, IBM, Intuitive Surgical, CSX, PPG Industries, Truist Financial, TAL Education, Travelers Cos
- Friday: Schlumberger, New Oriental Education & Technology
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