With roughly 35 percent of S&P 500 companies having reported, stronger than expected results have gone largely unnoticed as politics have dominated the investment landscape. Uncertainty surrounding future government regulations has overwhelmed positive corporate results and as a result, the S&P 500 has actually declined by over five percent since the earnings season began in mid January.
Outside of the market decline, the themes to the fourth quarter earnings season have been similar to the first three quarters of 2009 in that we have seen better than expected results across industry groups, improving guidance for 2010 and earnings improvements that continue to be influenced more by cost cuts than by end demand. However, the fourth quarter represents some significant differences from the earlier periods of 2009.
First, from a market perspective, during the previous three quarters, the S&P 500 sold-off heading into the earnings period and then rallied on better than expected results. Investors were skeptical of the recovery throughout the year as they focused first on cost-cutting, then on revenue stability and finally on signs of top-line growth. As the year concluded however, increased investor confidence in the economic improvement continued to propel the market higher.
The second notable change is that fourth quarter earnings represent the first positive turn in the earnings cycle. The trough in the cycle occurred last quarter when S&P 500 operating earnings fell 57 percent from their peak reached in the second quarter of 2007. Consensus estimates are for S&P 500 earnings to grow by 44 percent sequentially and roughly 65 percent on a year over year basis. The results so far have born this out. With 173 companies, or 35 percent of the S&P 500 reported as of January 27th, 79 percent have beat earnings expectations. The level of growth has also exceeded expectations with the aggregate number coming in at 89 percent growth. Additionally, the magnitude of beats, or the percentage that results are above expectations, is historically high at almost 12 percent. The breadth of the strong earnings has been notable as well with nine out of ten sectors showing positive earnings surprises and six out of ten sectors delivering positive earnings growth. And despite the decline in the overall market, individual companies have been rewarded for their efforts as those that have exceeded expectations have seen their one day share price increase by 0.6 percent on average.
The third divergence from previous quarters comes from the revenue side of the equation. Similar to the pattern playing out on the earnings side, revenues are set to post the first year over year increase since the third quarter of 2008. Roughly 53 percent of S&P 500 companies are estimated to post positive year over year revenue growth, and in fact, 21 percent are estimated to report top line growth of over ten percent. Actual reported revenue results are beating these expectations. Roughly 69 percent of S&P 500 companies have beat top line expectations with year over year growth coming in at almost ten percent. Even if you removed the somewhat distorted numbers from the financial sector, overall growth would still be roughly two percent. Breadth has been good on the revenue side too, with the overall beat averaging 1.25 percent and seven of ten sectors experiencing revenue growth.
Finally, the last significant factor that has differentiated this quarter from the last few is the earnings guidance going forward. So far, 13 percent of companies have increased guidance while just 2 percent have reduced guidance. The 13 percent level itself is high relative to the last decade, but perhaps more importantly, if that 11 percent spread between the two numbers held up, it would be the largest gap in more than 10 years.
So in summary, fourth quarter earnings are exceeding already elevated expectations and revenue growth is becoming a bigger part of the picture as companies gain greater visibility into their future earnings stream. However, a strong earnings season has yet to translate into a rising equity market. Perhaps the surprisingly high 5.7 percent GDP growth in the fourth quarter will bring a focus back to fundamentals as indicators like business spending, exports, personal consumption and housing all showed improvement while government expenditures decreased.
Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information.