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Q3 Earnings Might Not Reach Positive Territory

About two-thirds of the S&P 500 have reported third-quarter results, with 68% of the constituents beating estimates, better than the 66% historical average beat rate.

After earnings growth bottomed at -5.2% before the peak weeks of Oct. 19 and Oct. 26 when 200 companies reported, it began its typical upward trajectory. Now, growth is projected to decline 2.4% for earnings per share of $29.33.

Despite the encouraging 273 basis point (bps) improvement, we remain concerned that growth may not cross into positive territory for the third quarter because we are now entering the final stages earnings season. Historically, the average quarterly beat rate has been in the 400 to 450 bps range. If third-quarter results were to come in at the high end of that range, growth would end up being -0.8% for the first decline in growth since 2009.

Energy is weighing most heavily on growth rate, but that is not a new issue. In each of the first two quarters of 2015, energy earnings fell by 55%, yet the overall index was able to post positive growth in each quarter (albeit growth was only 0.14% in the second quarter).

The difference this time is that the materials sector is poised for an earnings decline of 14.6%, a decline that high hasn’t occurred since the third quarter of 2012. Consumer staples are also still projected to show lower earnings growth. Further, additional pressure can be attributed to weak growth from the information technology and financials sectors which are the largest sectors in the index representing more than 35% of the market capitalization on a combined basis. Growth of between 3% and 3.5% for these groups is pretty is weak compared to recent quarters.

Helping to offset the negative forces has been the outstanding performance of the healthcare sector. Growth has improved by more than 600 bps (more than any other sector) for a double digit year-over-year increase in earnings of 14.0%. Digging into the sector, beats have occurred across the board, with all subsectors showing improvement since the start of the reporting period. Biotech leads the upside move as its earnings beats have averaged 15% better than expectations.

Healthcare Subsector Q3 EPS Growth Trends

Healthcare Subsector Q3 EPS Growth Trends

These results indicate that despite recent concerns, fundamentals for healthcare remain in place. As a key driver of earnings growth for the past several quarters, with double-digit growth in each of the previous five quarters, we fully expect healthcare it to remain a leader this quarter.

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