For the last six months, two of the biggest factors impacting US corporate earnings have been the big rally in USD compared with other currencies, and the collapse in oil prices.
These two trends have had different and sometimes opposite impacts on trading, depending on the industry sectors. Lower oil prices have devastated oil producers and service companies but have been a boon for big oil consumers, such as transportation companies.
A higher US dollar has negatively impacted the earnings of big exporters and multinationals but may be neutral for companies with a domestic focus and even positive for US importers.
In this outlook, we shall take a look at how these two forces have impacted corporate earnings so far this year, review how the different industry groups have performed over the last quarter and year, analyse which stocks appear pricey and which look cheap relative to growth. Finally, we provide an outlook of how selected industries could perform in the upcoming earnings season.
The earnings reporting cycle
There is a fairly predictable cycle to quarterly earnings reporting over each calendar quarter. Most reports come out between weeks three and eight of each quarter. In the first month Alcoa usually kicks off earnings in the second week of the quarter along with some of the big US banks. Weeks three and five are the peak weeks and usually bring a flood of reports from the biggest names in technology, industrials, consumer products, health care, the remaining financials and more.
The second month of each quarter wraps up the main reporting season in the first half, with the second half of the month (weeks seven and eight ) dominated by US retailers and Canadian banks.
Generally speaking within a sector, the big caps usually report first followed by the midcaps and then the smaller companies.
The last month of each calendar quarter is relatively quiet for earnings. For this reason, when looking at quarter returns, I have used the end of the earnings season in February and May rather than the calendar quarter end.
What the street is expecting from major industry sectors in the coming earnings season
Source: CMC Markets, Bloomberg L.P.
Past performance and forecasting are the two ways of looking at stocks and sectors to figure out which may be overvalued and vulnerable and which may be undervalued and could present an opportunity. . Looking back, traders may consider stronger performance a sign of rising expectations. Looking forward, comparing the valuation traders are giving to a group relative to its growth rate may give us an idea of which areas appear expensive and which look cheap.
Looking backward, for the three months between the end of February and end of May, the S&P 500 was pretty much flat, so overall there was not much change to the expectations for corporate earnings. Through this time, health care was the top performing sector followed by financials and technology. The worst performing sectors have been industrials, materials and utilities, with energy also turning in a negative performance, suggesting that traders aren’t expecting much from those areas.
Looking forward, comparing the price/earnings ratio to the forecast growth rate, the 17.2x P/E for the market compared with a 7.1% growth rate gives a P/E to growth ratio of 2.42 which is moderately above the long-term expectation of around 1.
With their average P/E ratios but slow growth rates, utilities and consumer staples appear to be the most expensive and vulnerable with PEG ratios above 14.0 and 8.0 respectively. On the other hand health care, with its average P/E and high forecast growth rate, is the cheapest major sector with a P/E around 0.5. Because the street is expecting energy earnings to fall, we don’t count it in this analysis.
Financials are a bit higher than the market at this time, so banks may need to deliver strong results again. Technology, meanwhile, has a PEG ratio almost spot on 1.00, suggesting that technology stocks appears reasonably valued as a group. This can, however, vary dramatically on a company-by-company basis.
Except for the two areas indicated above, for the most part, the main industry groups don’t appear to be excessively valued relative to their underlying growth, so we may be in for another quarter of results more or less in line with estimates and sideways trending markets. That being said, within sectors, there are some areas that could perform better relative to others.
Energy: can the refiners repeat their stellar performance?
As poor as the results from many oil producers were last quarter, they were not a total surprise considering the devastating oil price crash. What was a surprise was how well the integrated oil companies and refiners did relative to the producers and services.
Source: CMC Markets
The chart above compares the performance of WTI crude oil and gasoline over the last year. Through the initial crash phase both commodities fell in lockstep but since the end of January, gasoline has bounced back much more strongly than crude oil. Heating oil, meanwhile, had a big seasonal bounce in the winter but has given back some of that edge in the spring.
The outperformance of gasoline and heating oil relative to crude oil in the winter helped crack spreads and refining margins, boosting the earnings of integrated and refiners. These spreads have narrowed a bit in the recent quarter, so the street may not be caught by surprise this time.
Group performance within the energy sector over the last three months also indicates that expectations for integrated oil companies and refiners have come off a bit over the last few months.
Interestingly, the shares of drillers and service companies have bounced back from very depressed levels over the last quarter, suggesting that the street may be thinking the worst of the budget cuts may be behind them, particularly since oil has rebounded in recent months. If we did get another round of budget cuts, however, these two groups could be vulnerable again.
Industrials: what the oil price rebound could mean for transports
The collapse of oil and gasoline prices in late 2014 was seen as positive for transportation companies as fuel is a big component of their cost base.
The rebound in gasoline prices since February, however, has cut into this price advantage. Because of this, expectations for windfall profits out of airlines, railroads and freight companies have come down in recent months. Airlines in particular, however, are still up dramatically from a year ago, suggesting that expectations remain high and because of this, they could be vulnerable if earnings fall short of estimates.
Because the US stock markets have been trending sideways for the last three months, we aren’t expecting a lot of major surprises in the coming earnings season. The biggest areas that still could cause some surprises are in sectors sensitive to swings in USD and in oil or fuel prices. The big rebound in oil prices over the last three months may have more of an influence than the relatively smaller pullback in USD.
CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
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