There's a 'high bar' to clear for third quarter earnings: Morning Brief

Myles Udland

·Head of News

Tue, Oct 6, 2020, 2:58 AM4 min read

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Tuesday, October 6, 2020

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Earnings estimates rose during the third quarter. That almost never happens.

Third quarter earnings season will begin in earnest next week.

But early returns suggest investors will be stingy in rewarding companies for topping expectations during this reporting period.

In a note to clients published Monday, UBS strategist Keith Parker notes early reports during this earnings season are topping revenue expectations by about 6% and earnings expectations by 20%.

But investors are not reacting to these results with all that much enthusiasm, an apparent carryover from second quarter earnings season. And high expectations could be to blame.

During the third quarter, Wall Street analysts raised their estimates for corporate results for just the fourth time since 2010, according to data from FactSet. Bottom-up earnings per share forecasts rose by 4.1% during the third quarter. Over the last decade, the average decline in earnings per share expectations is 4.4% during a given quarter.

In 2020, of course, we’d expect nothing less than a historical aberration.

And as analysts raised their expectations for company-level profits, so too did the broader market rise with the S&P 500 gaining 8.5% during the third quarter. FactSet notes that this is just the second time both earnings estimates and the S&P 500 have risen in the same quarter since 2000.

“Firms that reported Q3 already have declined -1% on avg despite the big beats, suggesting the bar is much higher for investors [to reward companies],” Parker writes.

“Thus far, a 10% sales beat seems to be a cut-off for positive stock returns. Stocks have more closely tracked developments in 2022 earnings more so than '21 and '20 EPS, so outlooks will be key. Past quarters with big S&P beats have seen momentum lag on avg, likely due to broader beats.”

This higher bar for third quarter results also comes as the rate and magnitude of positive revisions is at historical extremes.

“On earnings revisions, we are concerned about a number of industry groups where numbers have spiked to unsustainable levels, if history is any guide, and thus make them vulnerable for pullbacks,” said Citi strategist Tobias Levkovich in a note published Friday.

Software, autos, retail, and transportation are sectors that Levkovich flags as having been enthusiastically upgraded by analysts during the quarter, thus leaving the most room for a letdown.

But with the election coming up in just four weeks and news on additional fiscal stimulus or a vaccine also looming as potential catalysts for the market, the backdrop to this earnings season has rarely been more fluid. And leaves any of these realized or expected trends very much in doubt.

“In many respects, investors may be more focused on the upcoming elections, vaccine news and stimulus package developments since they all carry substantive impact on the outlook for 4Q20 and all of 2021,” Levkovich adds.

“Our sense is that management teams overall will continue with more reserved commentary amidst guarded optimism. The key will be thinking about lapping top-line comparisons for either Covid beneficiaries versus Covid impaired businesses as the calendar marches on into 1Q21. We suspect that CFOs have to be aware of such trends and analysts should be asking these questions in follow-up conference calls with the Street.”

By Myles Udland, reporter and co-anchor of The Final Round. Follow him at @MylesUdland

What to watch today

Economy

8:30 a.m. ET: Trade balance, August (-$66.2 billion expected, -$63.6 billion in July)
10:00 a.m. ET: JOLTS Job Openings, August (6.5 million expected, 6.618 million in July)

Earnings

Pre-market: