What To Watch As Fourth-Quarter Earnings Season Begins

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The pace of S&P 500 year-over-year earnings and sales growth has decelerated from the second quarter’s eye-popping levels, which benefitted from easy comparisons with Covid-ravaged 2020 and vigorous economic growth. While the earnings growth rate has slowed, earnings are still expected to grow at over 21% year-over-year. The impact of supply chain disruptions and any color about the timing of normalization will be significant for forecasts. Lastly, the effect of higher costs and the ability to pass on higher prices to protect profit margins will be closely scrutinized. For the quarter, robust economic growth and consumer demand should allow most companies to overcome the cost pressures and outperform earnings expectations. While it will be necessary for earnings to beat expectations, forward guidance will be essential with the continuing worries about cost pressures and earnings growth rates becoming more normalized in 2022.

S&P 500 Consensus Earnings Estimates: Year-over-year Earnings Change As of 12/31/2021

Glenview Trust, FactSet

There are 8 S&P 500 companies scheduled to report earnings this week, but the primary focus will be on the financials and the banks in particular. There are a handful of other companies like Delta Air Lines (DAL) on the calendar. Among the financials reporting are JPMorgan Chase (JPM), Blackrock (BLK), Citigroup (C), and Wells Fargo (WFC), so the big banks will provide an idea of the operating environment. According to FactSet, the financials should be around the bottom of the pack in earnings growth rates, with consensus year-over-year growth estimates of -0.7%.

Fourth-Quarter 2021 Consensus Earnings Estimates: Year-over-year Earnings Change As of 12/31/2021

Glenview Trust, FactSet

Bank stocks have outperformed sharply in 2022, rising almost 10% year-to-date, which does not seem to jibe with a decline in expected earnings. But under the surface, things are better than they appear. First, value stocks have been significantly correlated with yields, so the recent rise in interest rates and fewer concerns about the Omicron variant weighing on the pace of future economic growth has bolstered the shares. Financials comprise over twenty percent of the value index. Second, banks have already reduced loan loss reserves which show up in headline earnings, so the year-over-year comparisons are not flattering but disguise important improvements. Core bank earnings should be excellent and benefit from loan growth. In addition, wealth management and investment banking fees should be substantial.

Value Performance & Interest Rates: December 2019 To January 7, 2022

Glenview Trust, Bloomberg

While the industrial sector is expected to post year-over-year earnings growth of over 100%, this does not apply to the whole industry. Boeing (BA) and the airlines caused a huge year-over-year gain. This group of air travel-related companies posted a loss in the fourth quarter of 2020. Despite some companies still expected to have earnings losses, the relative improvement in earnings caused the spike in industry earnings. According to FactSet, earnings in the industrial sector should grow by 5.6% year-over-year if this group is excluded.

This season, the impact of higher costs and the ability to pass on higher prices to protect profit margins will be closely scrutinized across all companies. Labor costs will be a headwind for companies, with average hourly earnings rising at a 4.7% year-over-year rate in December. Companies have only re-hired 85% of the jobs lost during the Covid-lockdown, which helps offset higher labor costs. Higher commodity costs will also negatively impact most company’s profitability. The increase in commodity prices goes beyond oil, but as an example, the sharp rise in oil prices negatively impacts the costs for many non-energy companies. The energy sector had negative earnings in the fourth quarter of 2020, but the expected 66% year-over-year revenue reflects the oil price rebound in the fourth quarter.

Commodity Inflation: December 2019 To 2021

Glenview Trust, Bloomberg

Supply chain disruptions remain a significant issue for this earnings season. These disruptions both increased costs for most companies and resulted in lost sales for companies unable to secure the goods demanded by consumers. Increased shipping costs are almost certain to be a familiar refrain by the end of this reporting season. While shipping costs have retreated from their highs, transportation costs remain elevated. Despite these challenges, robust demand and increased productivity should allow the actual fourth-quarter results to exceed expectations.

Shipping Rates

Glenview Trust, Bloomberg

Aside from earnings, Federal Reserve (Fed) Chair Powell has his Senate re-confirmation hearing on Tuesday. Markets are already pricing in the first interest rate hike in March for a total of three increases in 2022, but will be sensitive to any clues of a change in the timing and pace of the hikes. Consumer inflation (CPI) readings for December, which are expected to be at a decades-high level of 7% year-over-year, should add to the pressure for the Fed to act in March.