A dealer works behind plexiglass on the ground of the New York Inventory Alternate (NYSE) in New York Metropolis, New York, U.S., July 28, 2021.
Andrew Kelly | Reuters
As we speak is the normal begin of third-quarter earnings. Here is the excellent news: Enterprise is sweet. Demand for many items and providers are excessive.
Here is the dangerous information: Provide chain points, labor shortages and better power costs are making this a really tough quarter to mannequin.
“This might be a tough quarter,” Academy Securities head of macro technique Peter Tchir stated. “There’s a actual concern that if inflation runs scorching it would suck away a few of the skill of customers to spend, even with what seems like stronger demand.”
Here is why analysts are apprehensive
Whereas at present is the “conventional” begin of earnings season, because big banks like JPMorgan Chase reported, there are 22 companies that have already reported earnings, some of them with quarters that end in August. Analysts and strategists watch these reports carefully because they are a good “early warning indicator” for earnings in the third quarter that has just ended, as well as fourth-quarter guidance.
There are two problems:
1. The early reporters are not beating estimates the way they once did. The 22 companies that are early reporters are beating estimates by 11%, according to The Earnings Scout CEO Nick Raich. While this is above the traditional beat of 3% to 5%, it is far below the average beats of prior quarters this year, including the roughly 18% beat for the second quarter.
2. Those early reporters are not providing guidance that is as strong as last quarter. As a result, analysts are not raising estimates as aggressively as they were in prior quarters.
What’s going on?
“The positive estimate revision of 2021 has slowed dramatically because of rising inflation and supply chain issues,” Raich said. “Companies are not nearly as positive as they were three to six months ago.”
As a result, earnings growth, which has been rising for the past several quarters, is now showing signs of peaking. Third-quarter estimates, for example, have been rising steadily for months but have stopped in the last few weeks.
S&P 500 third-quarter earnings estimates
(Year over year)
July 1 up 24.7%
Oct. 1 up 29.4%
Oct. 8 up 29.6%
Source: Refinitiv
The bullish outlook: the market is already adjusting
“This is going to be choppy, but some of it has already been broadcast by the broader market,” Canaccord Genuity chief market strategist Tony Dwyer said. He noted that financials, industrials, materials and energy — which are all cyclicals — underperformed all summer. “It was a summer of indigestion, and the markets were telegraphing it was going to be a difficult earnings season.”
Dwyer said we are now entering a “mid-cycle” phase of the economic recovery. During this period, earnings growth peaks, price-to-earnings ratios decline and the big market gains during the “early-cycle” phase become modest gains, or even reversals.
This has happened: The forward earnings multiple on the S&P 500 has gone from roughly 23 to 20, and the S&P 500 is 4% off its high of six weeks ago.
“The average stock, particularly in the cyclical sectors, have already reacted to the transition from early cycle to mid-cycle,” Dwyer said. “If we are consistent with prior transition phases, you want to buy weakness.”
How do you model supply chain disruptions?
Others are concerned that these disruptions will last much longer than anticipated, outstripping the strong demand seen lately.
The poster child for this quarter’s earnings quagmire is Nike, which reported earnings Sept. 23. While earnings were slightly better than expected, revenue disappointed. The company said supply chain problems — including 10 weeks’ lost production in Vietnam, where 40% of their sneakers are made — along with elevated times to ship product, significantly affected the company’s ability to deliver goods.
Nike also said demand was outstanding, including a record back-to-school season in North America.
While Nike’s stock price dropped about 6% when the report came out, it has since recovered most of its losses, as investors have chosen to believe that strong demand is more important than temporary supply chain disruptions.
What if Apple pulls a Nike?
The worry among investors is that “supply chain disruption and higher cost” will become the standard refrain for most companies in the third and fourth quarter.
What if, for example, Apple pulls a Nike and says they cannot deliver enough iPhones, even though demand is strong?
That’s what Bloomberg News reported Tuesday, saying the corporate was prone to reduce iPhone 13 manufacturing targets for 2021 as a result of chip shortages.
“There’s an assumption that Apple would have figured a method round this, so a affirmation of that will undoubtedly be a detrimental for markets,” Academy Securities’ Tchir stated.
Canaccord’s Dwyer, nonetheless, insists even that announcement will not have a long-term influence.
“Who on the planet hasn’t heard there’s a semiconductor crunch, a provide chain difficulty, and labor shortages?” he requested. “The query is not how lengthy is it going to final, the query is, when is it going to be discounted?”
How lengthy will demand stay sturdy?
Tchir agrees {that a} chip scarcity will not be a long-term downside, but it surely’s not clear how lengthy demand will stay this sturdy.
“My concern are persons are overstating how a lot future demand there’s,” he stated. “Everyone seems to be assuming that when the provision comes, the demand will probably be there. What occurs if the present buying behavior is exaggerating what the true demand is? It is attainable demand has been pulled ahead due to all these reviews of shortages.”
“Assuming that demand remains to be going to be there in just a few months is a danger,” Tchir stated. “We might have the other downside: as a substitute of a scarcity of product, we now have a listing construct.”
“It is undoubtedly going to be an fascinating few months.”
