Trader Talk

Early indications point to a surprisingly strong second-quarter earnings season

Key Points
  • Only two dozen companies have reported earnings for the second quarter.
  • Earnings so far are up nearly 12 percent from the second quarter of last year.
  • Analysts say the revenue turnaround will be the big story this season.
Better-than-expected earnings take Wall Street by surprise

We might be in for a big surprise when it comes to second quarter earnings.

It's early — only two dozen companies (about 5 percent of the S&P 500) have posted earnings for the period, but the results from the early reporters like Nike, Oracle and Darden have been surprisingly strong.

Profits from those 23 companies are up nearly 12 percent from the second quarter of last year, according to Nick Raich, who follows the markets as the Earnings Scout — continuing the earnings rebound that began at the end of last year. But revenues for those companies are up 8.5 percent, with nearly 90 percent exceeding estimates, far above normal.

For Raich, the revenue turnaround is the big story: "It's not just cost cutting any more. One of the bear arguments has been that what little earnings growth we have seen has been cost cutting and buybacks. But if you have revenue growth, it takes away a lot of the bear argument. And it shows you business activity has improved."

Indeed, the bottom for earnings and revenue for the S&P was the first quarter of 2016, and we have been steadily improving since then.

But 5 percent is a small sample — what about the 95 percent that have not yet reported? Earnings estimates for those companies are not being reduced nearly as much as in prior quarters.

Earnings estimates typically come down as we go through a quarter, but this time estimates for the entire S&P 500 are only 2 percent lower than they were at the start of the quarter in April, according to FactSet. That is well below the usual reduction of about 4 percent.

"This tells me analysts are more optimistic than usual," John Butters of FactSet told me.

Raich concurs: "It's a sign most of these companies are comfortable with the estimates. Otherwise, they would have guided down more aggressively."

As for the third quarter, which we have just started, the early signs are also positive, as estimates are also holding up better than expected. Right now, according to Raich, 43 percent have seen their third-quarter estimates go higher for the period. That's the highest level in five years.

Of course, there are outliers, and for those, analysts have been quick to take down numbers. Take Bed Bath & Beyond, which had its third-quarter earnings estimates reduced by analysts nearly 7 percent after the company reported "increased softness in transactions in stores, as well as higher net-direct-to-customer shipping expense, coupon expense and advertising costs during the quarter."

Homebuilder Lennar beat its earnings estimates after it reported on June 20, but analysts overall reduced third-quarter estimates as many noted that valuations were stretched and there may be limited upside to housing after several years of strong growth.

But they are in the minority. Earnings season doesn't really start until July 14, when JPMorgan and Wells Fargo report, but Raich is encouraged by what he sees.

"It's a small sample, but it's a really good start," he said.