Markets Remain Focused On Q1 Earnings Season – Economic Highlights

The Q1 earnings season is in full swing, with this morning’s long line-up of results from the likes of Coca-Cola (KO), McDonald's (MCD), Boeing (BA) and others adding to what we have been seeing repeatedly this earnings season. The common theme is revenue weakness – not only are top-line growth rates very low, but an unusually small ratio of companies are able to come ahead of consensus top-line expectations.

Unlike the below-average revenue-beat ratios, companies are finding it easy to beat EPS estimates at an above-average rate even through earnings growth is equally challenged. The three companies mentioned here don’t exactly follow this script – Coke beat on both the top and bottom lines, McDonald's missed earnings and Boeing beat on earnings but came short on the top line.

Including these reports, we now have Q1 results from 121 S&P 500 members that combined account for 31.3% of the index’s total market capitalization. Total earnings for these 121 index members are up +11.2% on +1% higher revenues, with 71.1% beating EPS estimates and 35.5% coming ahead of top-line expectations. This is weak performance relative to what we have seen from the same group of companies in the recent past.

Yes, the earnings growth rate (+11.2%) and earnings beat ratio (71.1%) is tracking above what we have seen in other recent quarters, but it’s hard to get too excited about that. The earnings growth rate is solely due to easy comparisons at a couple of big players in the Finance sector – Bank of America (BAC) in particular – while the high earnings beat ratio is a reflection of how low expectations had fallen ahead of the start of this earnings season.

As referred to earlier, the standout theme emerging from the earnings results thus far — which will most likely carry through to the end of this reporting cycle — is the top-line weakness. A combination of weak U.S. economic growth, a strong dollar and Energy sector weakness has been a headwind for revenues this earnings season. Most companies are guiding lower for the current period, which is causing estimates for Q2 to come down even more.

With respect to the U.S. economy, the consensus view is that we lost growth momentum due to bad weather in the East Coast and port issues in the West Coast. In other words, the Q1 GDP slowdown is essentially a one-off, with the economy expected to bounce right back along the lines of what we saw last year. We will see if this view plays out in the coming days. But if it does, that will mean an interest rate normalization from the Fed, likely in September.

Perhaps the best case for stocks would be if the U.S. economy to gets a little bit better from the Q1 level to help improve the earnings picture, but the improvement isn’t strong enough to keep the Fed on the sidelines. In other words, stocks need a Goldilocks backdrop to get out of the range they have been stuck in lately.