11/03/16 04:08 PM EDT

3Q Earnings Scorecard | IT DEPENDS ...

Christian Drake

Ben Ryan

Anytime it’s a struggle to summarily characterize and contextualize a rash of data, it generally means its underwhelming.

Consider the “It Depends” ambiguity of this morning’s macro:

Productivity rose 3.1% QoQ in 3Q16, breaking the worst streak of negative sequential growth in 4 decades. But it was also negative year-over-year for a 2^nd consecutive quarter, marking the worst streak in 23 years … and the positive distortion in net exports and unsustainable inventory build that drove the upside in output in 3Q are likely to deliver decreased contributions to headline growth in 4Q.
Unit labor costs were up which is good for workers but they are still rising faster than output prices which is margin negative for businesses.
Real & Nominal GDP accelerated sequentially but are still rising slower than payroll and aggregate income growth, respectively, which means profitability (& near-term productivity) will remain under pressure.

The trend in 3Q16 earnings can be similarly characterized:

The earnings trend is showing marginal improvement and earnings growth seems likely to close positive this quarter ….. but it’s largely base effect driven, the 2Y comp is still -0.85%, the industrial profit recession remains ongoing and forward estimates remain overly optimistic.

With three quarters of SPX constituents having reported here’s the scorecard summary:

DOUBLE DIP: So far 61 out of 68 companies in the industrials sector have reported earnings growth down -3.3% Y/Y. We reiterated our Double Dip recession theme for the manufacturing side of the economy in our Q4 Macro themes presentation and added the sector as a short idea simultaneously. Durable goods orders, Industrial Production, ISM’s and Construction spending have confirmed that theme over the last couple of weeks. Industrials slightly trailed the S&P 500 for October and are currently tracking in line with beta, down -3%+ QTD.
OPERATING MOMENTUM: Just 50% of companies have recorded sequential acceleration in earnings growth while 56% have shown sequential margin expansion despite. While a modest improvement to the recent quarter trend, 2nd derivative trends in operating performance remain conspicuously underwhelming despite comping against 5 quarters of negative growth. In the industrial space, just 40% and 47% of companies have registered sequential improvement in earnings growth and operating margins.
MISSING’S MATTERED: 75% of companies that have missed earnings estimates have gone on to significantly underperform the market (-5.2%) over the subsequent three days. Sales misses have been similarly received with 62% of companies missing topline estimates going on to underperform by -4.4%.
CLIMBING A STEEP CONSENSUS SLOPE: We continue to think earnings growth expectations look overly optimistic and are juiced to justify owning current multiples that have, in just the last two weeks, come off of cycle peak. NTM revision trends have been biased positive thus far in October and the early intra-quarter revision trend suggests forward estimates haven’t backed off at all. As it stands, S&P 500 earnings growth estimates for the next four quarters starting with Q4 2016 are +6.4%, +14.9%, +11.7%, and +11.0% for Q3 2017.
ENERGY OPTIMISM: With earnings growth estimates having recouped nearly all the ground lost in early 2016, optimism around an energy sector recovery continues to support forward expectations. While pulling back in recent days alongside the correction in crude, forward multiples in the energy space remain very close to the highs and remain levered to a prevailing expectation for further price inflation in energy products.