We threw up a note for Materials subs earlier this week with a Q1 earnings update and feel it is important to continue pounding the table on earnings and current multiples from a broader market perspective.

Now that the S&P 500 is going on 3 consecutive quarters of negative Y/Y earnings growth, forward looking - earnings expectations have been taken down – no surprise…

Given the fact that the market is trading at peak forward multiples again, is an earnings beat a positive in a declining earnings, peak multiple environment? The degree of late-cycle corporate gamery (buybacks and M&A) and unprecedented earnings manufacturing is widely discussed and understood, and we assume it gets factored into analyst models.

So far this earnings season:

  • S&P 500 Earnings are down -5.6% Y/Y
  • 6/10 sectors have comped down bottom line
  • 7/10 have comped down top line

Looking at expectations, 6/10 sectors have missed top-line expectations, but every sector has blown out bottom line expectations (see chart below). Despite that fact that everyone knows earnings metrics are being manufactured aggressively, actual prints are far exceeding expectations. 

Do Earnings Matter? - Comps   Beat.Miss

We find it hard to entertain “forward expectations have undershot to the downside” arguments when earnings growth is down -5.6% Y/Y, 6/10 sectors have missed top line, and every sector has exceeded bottom-line expectations to get to that -5.6% number. S&P earnings have beat estimates by 4.2% in aggregate.

AND, with the shift in financial reporting leeway, we can assume that today’s current peak multiple could be higher than it already is from a normalized historical standpoint. So, the most important question to ask is Can you find a catalyst to buy at peak multiples into what could be a fourth consecutive quarter of negative Y/Y earnings growth in Q2?.

The broader market has been trending higher as of late, but as DD outlined in Reflation Reversal Risk , the policy catalyst will be less muted than it was in January/February if that's what you're looking for – It’s mostly a matter of psychology and positioning, outlined in the note. Below we show two slides from our macro deck that outline the easiness/difficulty of Q1 and Q2 comps. The takeaway is that easy comps won’t be in front of the market until Q3/Q4 if you're looking for a reason to buy on earnings:

Do Earnings Matter? - Q2 2016 Comps

Do Earnings Matter? - Corporate Profit Peak

To sum up the cycle view, corporate profits and operating margins peaked in 2H 14 are now poised for what could be 4 quarters of negative Y/Y earnings growth, so despite a psychological boost from a “beat” the rate of change in corporate profitability is meaningful (visual below) and continues to decelerate with the market buying at peak multiples.

Do Earnings Matter? - S P 500 NTM Multiples