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4Q19 EPS

In the minds of investors, the soon-to-end fourth quarter earnings reporting season has taken second place—if not all but ignored seemingly—to the deadly outbreak of the coronavirus in China. That’s unsurprising, given the DefCon 1 level of fear that disease has engendered. But we’re not doom and gloom types here. I expect the spread will be contained and we won’t see another 1918 Spanish flu. (Fingers crossed.) The concern about coronavirus has overshadowed what’s turned out to be a fourth quarter among the companies in the Standard & Poor’s 500 index (SPX) that is better than expected, with the great majority of the companies having reported already by now. For example, according to FactSet, to date, 77% of SPX firms have reported actual results for Q419. In terms of earnings, the blended EPS growth rate (which combines actual results for companies that have reported and estimated results for companies that have yet to report) for 4Q is positive at 0.9%. This has steadily improved since the -2.4% expected when the reporting season kicked off. Similarly, over the same period, blended revenue growth is 3.6%, above the 2.8% expected a few weeks ago. Zack’s Investment Research, in a recent report, said that “we can say with a fair amount of confidence that the Q4 earnings season has turned out to be a good one, with decent momentum on the revenues side and earnings growth on track to turn positive.” Zack’s adds that in general a much bigger proportion of SPX companies are beating top-line estimates, even as the EPS beats percentage is tracking below historical periods. Additionally, the 4Q estimate revision improvement trend is easing, and that could be due to coronavirus fears. The outbreak has clear negative earnings implications, as many companies like Starbucks (SBUX), Disney (DIS), and Pernod Ricard, among others, have publicly acknowledged. Second, profits growth is tracking to turn positive in 4Q. That’s something we can see from the FactSet numbers. (It should be noted that the two data providers don’t always present the quarterly earnings in the same way.) And while we are looking at what’s likely to be flat SPX EPS in 2019 from 2018, at $162, investors should remember that 2019 results are being compared to strong 2018 earnings, a year in which the Trump corporate tax rate reduction took effect and rained artificially high profits on companies. Ironically, the market fell on a price basis in 2018 but soared nearly 30% last year, when earnings growth was nil. What’s also notable about the fourth quarter is that it’s the first one in 2019 in which results turned positive for the period. In the previous three quarters of 2019 results did improve compared to estimates as the reports came in but remained in negative territory. Remember the so called “earnings recession?” While things should normalize this year and we’ll get to that below, investors should expect that when the outbreak is finally called “contained” the pressure on earnings for a number of industries, restaurants, airlines, luxury companies, to name a few, as well as companies based in or with a big presence in Asia will likely be hit in the first quarter of 2020. You can expect that, for example, China’s Alibaba (BABA), travel operators TripAdvisor (TRIP) and Expedia (EXPE) will see a hit to profits. Unfortunately, it will take time to assess the full extent of the virus. This might manifest itself in stock price pressure. Will this be a one quarter phenomenon—1Q20—or will it bleed into the second quarter or later of this year? I think the former, but it is hard to tell. A big bright spot in the fourth quarter is technology, a sector we happen to like a lot. In general, with the great majority of tech companies (by market capitalization) having reported, total earnings (or aggregate net income) are up roughly +5.5% from the same period last year on about 6% higher sales, according to Zacks. Over 80% of companies are beating both EPS and revenue estimates. This is a notable improvement in performance versus the previous three quarters of 2019. Looking ahead, FactSet says that analysts see earnings growth of 2.5% to 5% for Q1 2020 and Q2 2020. The broad market is trading around 19 times this year’s bottom up EPS estimate of $177 and 17 times next year’s $195. So, what about 2020? Our very own Tom Lee makes a good case for U.S. growth to begin reaccelerating later in 2020. As we’ve noted previously, three factors suggest this: the US Purchasing Managers Indexes are bottoming, key groups sensitive to PMIs are rallying, and ISM New Orders/Inventory looks like it has bottomed. The market closed Friday around 3338, up 3.3% YTD and we see further upside ahead. Questions? Contact Vito J. Racanelli at vito. racanelli@fsinsight. com or 212 293 7137. Or go to

Better 4Q19 EPS, Guidance, Economy Could Boost Market in 2020

Forgive me for harping on the “earnings recession” fears that have hung over the market for some time, but it pays to remember just how concerned most investors were 12-18 months ago. Now, however, this one-time bogeyman is in the process of likely resolving itself and fading away. That has implications for the bull market. (See Signal From Noise, Market to Focus on SPX EPS Growth after 4Q19 EPS Season, Jan. 15.) I say this for a couple of reasons. Acknowledging right away that the fourth quarter 2019 results currently emerging are just a small sample of the entire Standard & Poor’s 500 index (SPX) companies yet to report, they are already better than forecasts. Moreover, the better numbers are coming from important companies. As results continue to exceed the “EPS recession” analyst forecasts, I believe it will be enough to shrink equity risk premium, and create market upside. O.K. Last week, the earnings seasons kicked off and for the 32 S&P 500 index companies that have reported thus far, 78% are beating and the average beat has been 2.4%. This is strong relative to both analyst and investor diminished expectations of down 1.5%. I expect SPX companies to continue to mostly deliver results above lowered expectations, striking a generally positive tone for 2020 growth. Let’s look at the numbers so far. These 4Q19 EPS results are pretty meaningful, with notable beats this week from JPMorgan (JPM) beating by 11.5% and 530bp on sales growth. Broadly speaking financials did well, with beats from Citigroup (C) +15.2%, Blackrock (BLK) +11.5% and Bank of America (BAC) +6.0%. But then cyclicals did well, too, as Delta topped expectations nicely (DAL) +22%. Source: FS Insight, Goldman Sachs The beats have been broad as both cyclicals and defensives have seen good results. The magnitude so far is nearly 5% ex-financials and ex-energy. It’s reasonable to think that the fact that some beats are greater than 10% (or +1,000bp) highlights the difference between diminished consensus expectations and the underlying better performance being seen, if only so far. Guidance for 2020 is also positive given the fading headwinds of US-China trade war. Economists see upside to 2020 GDP growth (See chart nearby). With the US-China signing the Phase I trade deal recently, overall visibility for companies and markets should improve and if there were significant drag effects in 2019, the combined effect should be upside to growth in 2020. This is the rationale used by economists in modeling upside in 2020. An example is the work by Jan Hatzius at Goldman Sachs, with his model showing a drag of 40 bp/quarter in 2019 fading to 0 this year or 40 bp lift, which is substantial. More support comes from the fact that financial and monetary conditions have eased so much that about 60% of leveraged loans are trading above par, a 14- month high according to JPMorgan’s high-yield credit team led. With strong pricing for bonds and tightening spreads, this should bolster CFO confidence, another factor for why 2020 guidance should be positive, in my view. Now, combine these three points—4Q19 beats, better outlook and easing financial conditions—and you have a strong argument for the idea that the equity risk premium will fall in 2020. Crucially, while SPX EPS is expected to grow about 10%, I think that the upshot of a strong 4Q19 results season is likely a further expansion of market’s P/E multiple, currently a bit more than 18 times. Source: FS Insight, Bloomberg A proxy for equity risk premium (ERP) is the SPX earnings yield less the U.S. Treasury 10-year bond yield. The current level, 3.4%, is well above the 30-yr average of 1.9%. The sensitivity table below shows comparative ERP levels and the associated implied S&P 500 price. If the ERP were to fall to 3.0% (40bp), this would increase the S&P 500 to 3,576 (+275 points) and as noted above, each 50 bps is worth about 2 P/E multiple points, or about 10% upside. What could go wrong? A systematic shock like a geopolitical event could cause business visibility and investor confidence to collapse. Bottom line: I expect a strong 4Q19 EPS results season (playing out so far), with the resulting impact on equities being a further decline in equity risk premium. I think stocks are in the process of seeing a decline in ERP from elevated levels (3.4% is near the 1-standard deviation high of 4.2%). The following 20 stocks (1) currently have an above average ERP, (2) are estimated to have a YoY EPS growth in 2020, and (3) are highly ranked in Fundstrat Quantamental model. The tickers are BWA, F, GM, PHM, NCLH, EBAY, HOG, ARNC, SNA, JNPR, INTC, HPQ, NTAP, LYB, EMN, COF, SYF, KEY, MTB and DISCA. Figure: Comparative matrix of risk/reward drivers in 2020Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019 Source: FS Insight, Bloomberg

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