What Does the Q3 Earnings Season Indicate for Q4 and Beyond?

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Earnings season is usually an exciting time for traders, and can be for investors, too. The release of companies’ quarterly reports can cause some wild swings in stock prices, making it a time of heightened opportunity (and also heightened risk, of course) for traders, while those with a longer-term outlook can see trend reversals in either direction in stocks that they own. Those swings in the fortunes of individual stocks are the focus for a few weeks but, once the dust settles, what matters to investors most is what the last quarter’s earnings say about the market for the next few months.

What has this most recent earnings season told us? My starting point when looking for answers to that question is always the FactSet Earnings Insight, a reliable source for the raw data, and also some analysis.

The numbers show that a lot of companies, around 82% in fact, beat analysts’ expectations for earnings per share (EPS) in calendar Q3, with 62% beating on revenue. That 82% number is high, even higher than the already high average number of beats over the years, which runs at 74%. That has been achieved despite only 62% beating estimates for revenue, which is below the 64% 10-year average. That discrepancy between profits and sales makes sense in an economy with falling inflation, given that price hikes due to higher input costs are often not reversed when those costs fall.

Joe Biden called that "price gouging" on Monday, but some may prefer to look at it as just a normal fluctuation in margins, something that will even out over time. They would argue that inflation is still a thing, even at 4% rather than the 9% we saw last year, and companies considered its stickiness when boosting their prices. They “future proofed” to avoid a series of increases. Which side of that argument you find more convincing probably depends on where you sit on the political spectrum, but there is likely some truth on both sides. The point is, whether it gets regulated away or just fades over time, the boost to margins that we have seen in this earnings season will be a temporary thing.

That belief is borne out by the guidance changes that have been issued during the season. Thirty two of the S&P 500 companies issued positive guidance revisions this quarter but twice as many revised their guidance lower. Interestingly, though, FactSet’s research also points to a considerable reduction in the use of words like “inflation” and “recession” in earnings report comments this quarter, things that might explain corporate pessimism. It seems that many management teams feel a sense of foreboding, but can’t quite put a finger on why that may be.

That is similar to the phenomenon among U.S. consumers that I talked about yesterday, where 70% of Americans believe we are in bad shape, but Black Friday spending was still at record levels. I wrote that consumers’ actions spoke louder than words, but on a corporate level, it is a bit different. People typically spend according to their immediate level of disposable income, but businesses plan expenditures years, if not decades, ahead. That makes even a vague feeling of uncertainty among CEOs quite a powerful thing. And if businesses cut back their spending, we will all feel the pinch.

However, if you look at the most basic measure of a capitalist economy’s health -- corporate profits -- it seems that far from struggling, as some believed would be the case in the second half of the year, American corporations are thriving. Still, there are some questions as we move into Q4 and beyond. Despite data that show that things are fine right now, corporations are a bit pessimistic overall on the immediate future and, should that pessimism lead to cutbacks, it could easily become a self-fulfilling prophecy. Then there is the fact that the good EPS performances for last quarter could be just a temporary thing, a result of extraordinary circumstances that have led to a lot of companies effectively front-loading their profits to avoid having to put prices up again soon.

Add all that up, and you have an uncertain but mostly balanced outlook. There are risks, for sure, but they are not new risks. So far, the U.S. consumer and the U.S. economy have managed them, and both are still ticking along. A big boom looks unlikely any time soon but at the same time, the risk of a big collapse recedes with every month that one is avoided. We are stuck in a kind of limbo, and the market reflects that at current levels, with forward P/Es right around their historical averages.

As a writer and a pundit, it would be nice to draw a sensational conclusion from this earnings season. After all, a headline that says “Massive Bull Run Imminent!” or “A Crash is Coming!” garners more attention than “Sideways, Blah Blah Blah” ever will, but a dispassionate view of the evidence indicates that as we go into the last quarter of the year, stocks look accurately priced, while risks look equally balanced. So, as boring as it is, the message from this earnings season is that “Sideways, Blah Blah Blah” is what investors can expect for a while.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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