By David Aurelio
The unofficial kickoff to the Q1 2017 earnings season is set for April 13, 2017, when several of the Financials sector's banks are expected to report results for the quarter. Heading into the quarter, year-over-year (Y/Y) growth is expected to be strong for both earnings and revenue. As a result, the S&P 500 will likely post the highest growth in over 5 years.
Exhibit 1. S&P 500 Banks Industry Q1 2017 Key Performance Indicators
Banks in Focus
With the S&P 500 Banks Industry Index (.52P40101010) down 1.69% YTD, as of the April 12 close, focus will be on the four constituents expected to report quarterly results before the market on April 13, 2017, as they could set the tone for the Q1 2017 earnings season.
The Financials sector is expected to see the second highest Y/Y earnings (+15.3%) for Q1 2017. Revenue is expected to grow by 7.5%. Within the sector, the Banks industry is expected to grow Q1 2017 earnings by 10.0% and revenue 3.2%. In aggregate, Q1 2017 net interest income for the industry is expected to climb $3.1B (+5.5%) from the prior year. Net interest margin for the quarter is expected to increase 0.1 ppts to 2.7% and the efficiency ratio is expected to decline 1.5 ppts to 61.0%.
Exhibit 2. S&P 500 Historical & Expected Y/Y Earnings and Revenue Growth Rates
Earnings for the S&P 500's first quarter of 2017 are expected to increase by 10% from the prior year and revenue is expected to grow by 7%. If this holds, Q1 2017 will have the best first quarter Y/Y growth since Q1 2011, when earnings and revenue grew by 18.9% and 9.4% respectively.
The S&P 500's 10% Y/Y earnings growth rate is the highest since Q3 2014's 10.3%. However, on average, 64% of S&P 500 companies exceed earnings expectations, which lead the index post earnings above estimates by a median of 3.7%. As a result, Y/Y earnings tend to improve as earnings season proceeds. Therefore, it is likely that the S&P 500's Q1 2017 Y/Y earnings will exceed 10.3% to be the highest since Q3 2011's 18.0%. This quarter is also likely to be the highest Y/Y revenue growth (+7%) since Q3 2011's 11.1%.
Exhibit 3. S&P 500 Q1 2017 Y/Y Growth Rates & Percentage Point Contributions
The Energy sector's easy comparisons to negative earnings in Q1 2016 are expected to see Y/Y earnings increase by 597% and Y/Y revenue of 35.7%. As a result, the sector is the largest contributor to the S&P 500's Q1 2017 Y/Y growth and adds 3.8 ppts to Q1 2017 Y/Y earnings and 2.5 ppts to Q1 2017 Y/Y revenue. Within the sector, the Integrated Oil & Gas sub-industry is expected to see the largest Q1 2017 Y/Y earnings (379%). Analysts expect the group to reduce total production for Q1 2017 by 2.3% from the prior year and upstream income to increase by $3.8 billion (274%) from Q1 2016.
On the flip side, the Industrials sector is expected to see the largest decline in Q1 2017 Y/Y earnings (-5.4%). Faced with tough comparisons and higher fuel costs, the Transportation industry group's Q1 2017 Y/Y earnings decline of 17.7% is the largest drag on the sector. However, the group is expected to see Q1 2017 revenue climb 6.2%, which is the highest within the sector.
Exhibit 4. S&P 500 Expected Effective Tax Rates
Tax Policy Expectations
One question that often comes up when looking at the high earnings growth rates for the S&P 500 over the next several quarters is if analysts have incorporated expectations for tax reform within their estimates. The aggregate effective tax rates for the S&P 500 in Q1 2017 through Q1 2018 show that tax reform is not baked into earnings estimates, which is expected to average 30.1% over the five quarters. The Real Estate, Semiconductors & Semiconductor Equipment, and Pharmaceuticals, Biotechnology & Life Sciences industry groups are expected to have the lowest effective tax rates in Q1 2017.
Companies appear to be more positive on their guidance for the quarter than historical averages. There have been 80 negative earnings pre-announcements compared to 32 positive, which provides an N/P ratio of 2.5. This 2.5 N/P ratio is below the long-term average of 2.8 and below the prior four quarter average of 4.3. The Semiconductors & Semiconductor Equipment industry group is the most positive and has an N/P ratio of 0.1, with one negative guide, 11 positives, and two in line with estimates. Conversely, the Retailing industry group has provided the most negative guidance, with nine negative guides and no positive or in line.
Most of the primary measures look strong heading into the Q1 2017 earnings season. Not only are Y/Y earnings and revenue likely to be at the highest levels since 2011, companies are signaling positive sentiment through their guidance. Finally, earnings results for the 5% of companies that reported Q1 2017 have come in above estimates. So far 72% of S&P 500 beat Q1 2017 earnings expectations, which is above the long-term average of 64% and above the previous four quarter average of 71%.