A review of the US Q2 Earnings Season – what insights have we gained?
- iFAST Macro Research Team | Published on 06 Sep 2021
- The US Q2 earnings season has been positive, as it has generally shown positive earnings surprise (by 17%) as well as strong earnings growth (by 93.7% QoQ).
- Earnings are also becoming more broad-based, with all sectors showing positive earnings growth, and all but one sector (utilities) showing double-digit earnings growth.
- When comparing to previous bear markets in history, as well as with other DMs in the present, we also find that this earnings season has performed favourably.
- Macro outlook remains strong, but valuations are a major concern – there may be some frontloading of estimates.
- Overall, we are positive on US growth, but think that much of this positivity has already been priced in.
Equity markets have performed well so far this year, with S&P500 climbing more than 20% year-to-date, and over 10% in Q2 itself. In this article, we analyse the results from the recent Q2 21 earnings season, which is near its conclusion, with 490 of 498 companies in the S&P500 (98%) having reported their earnings so far as of 31 Aug. We look at possible conclusions we can draw from this earnings season, and consider the outlook in the months ahead.
Majority of the US companies are beating estimates
A large majority (86%) of S&P500 companies have shown positive earnings surprise (i.e. actual earnings have beaten consensus estimates) this quarter. This is also a high figure compared to recent history – in 2019 and 2020 combined, we see 76% of S&P500 companies showing positive earnings surprise on average.
However, the magnitude of earnings surprise has fallen. Q2 saw earnings beat consensus by approximately 16%, compared to 22% in Q1. While the extent of earnings surprise has dipped, we do not think it is due to a deterioration in earnings strength – we will see later that earnings growth has actually improved. Instead, we attribute this observation to soaring market expectations.
Sales and earnings growth remain robust
We see a similar trend in sales: a large majority of S&P500 companies have also beaten sales estimates in Q2 (83% in Q2, 72% in Q1), and the extent of sales surprise has also been solid at +5% (in pre-COVID times like 2019, we would roughly see a 0 to 1% sales surprise each quarter). In fact, we observe an increasing magnitude of sales surprise each quarter since Q2 20 (peak of pandemic).
Meanwhile, sales and earnings growth are also stronger in Q2. Earnings grew 92% in Q2 (compared to 50% in Q1), and sales grew 25% in Q2 (compared to 11% in Q1).
Collectively, the proportion of companies beating earnings, magnitude of the earnings beat and strong Q2 earnings growth (albeit influenced by base effect) are telling signs that the US corporate earnings recovery is still chugging along at a healthy pace. There are also little signs that earnings are likely to moderate moving ahead. In our view, the higher market expectations appear to be backed by solid earnings fundamentals.
Chart 1: Q2 earnings performance has remained strong in Q1 and Q2
Broad-based growth across multiple sectors
In our previous US earnings update, we reported that earnings surprises were mainly led by Financials, Consumer Discretionary, Communications, and Technology. In this quarter (Q2), these sectors continue to lead in earnings surprises. In particular, Financials, Consumer Discretionary and Communications beat earnings estimates by over 20% in Q2. Financials have benefited from the strong performance of banks, helped by the latest Fed stress tests, and the prospect of rate hikes as early as 2022. Consumer Discretionary and Communications are benefiting significantly from the digitalization of the economy, with online shopping becoming more ubiquitous, helped by the continuing of work-from-home arrangements.
However, there are signs that earnings strength is becoming more broad-based. For the pro-cyclical sectors mentioned above, there was actually a huge drop in earnings surprise, such as in the Consumer Discretionary sector (58% surprise in Q1, to 22% in Q2), though this was mainly due to higher estimates rather than any sectoral weakness. On the flip side, some traditionally non-cyclical sectors like healthcare and utilities have seen a relatively higher earnings surprise compared to the previous quarter. In particular, one sector of note this quarter is Healthcare – although it “only” saw a 9% earnings surprise this quarter, a large proportion of Healthcare companies saw positive EPS surprise (60 of 65 reporting Healthcare companies, or 92%).
We are also encouraged by the fact that all sectors in the S&P500 (classified by GICS) are showing positive sales and earnings surprises, as well as positive sales and earnings growth compared to the previous quarter. Furthermore, all sectors but utilities (known to be a defensive sector) saw a double-digit growth in both sales and earnings in Q2. This further supports the narrative that the US earnings recovery is broadening out, with all sectors expected to grow robustly over the rest of 2021.
We believe this development in earnings strength on a sectoral level is positive for the economy. With many sectors showing strong earnings, the US economy is poised to maintain its robust recovery for the rest of 2021.
Chart 2: Earnings surprises are more balanced in Q2
Earnings have recovered well compared to previous bear markets
Chart 3 shows how EPS of the S&P500 has varied over time. In particular, we highlight the Dotcom Bubble in the early 2000s, the Great Financial Crisis (GFC) in 2008 – 2009, and the recent COVID-led slowdown in 2020.
- The recent recovery in EPS has been swift (taking about 2 quarters to reach pre-crisis levels), similar to the GFC and faster than the Dotcom Bubble.
- The decline in EPS as a result of COVID, was not as severe as the decline observed during the GFC (but still sharper than the Dotcom Bubble, which lasted for a longer period).
- EPS has continued to increase sharply above pre-COVID levels. In comparison, we only saw a moderate increase in EPS after the Dotcom Bubble and GFC.
We view these observations positively, as they suggest that the ongoing recovery is thus far more robust than previous bear markets, likely due to the massive influx of fiscal and monetary stimulus.
We are optimistic after comparing the most recent COVID bear market to previous bear markets, as EPS has fared significantly better relative to history.
Chart 3: EPS has recovered better versus previous bear markets
Earnings remain supported
On the vaccination front, 74% of the US adult population has now received at least 1 dose, and 63% of the US adult population is fully vaccinated. Some companies, like Google and Facebook, have also mandated vaccinations for US-based employees. This means that the US is much closer to achieving herd immunity compared to the previous quarter (though Fauci has refrained from setting a specific vaccination target rate).
We therefore think that the consumption rebound we forecast in the previous quarter, still has room to run, as the prospect of another lockdown is now diminished. In addition, while the US labour market still looks fairly anaemic, we expect hiring to pick up considerably once the delta variant threat is diminished, which should put more money in the pockets of US consumers. These factors should continue to support earnings performance of the Consumer Discretionary sector.
The Financials sector is also poised to continue stable earnings growth in Q3, continuing a trend from previous quarters. In the previous quarter, we highlighted an improving credit environment as a key factor lifting this sector, and we expect this constructive environment to continue for the rest of 2021. We also see improving fee income and potential rate hikes as early as 2022, which will help to support revenues as well.
Further, we remain optimistic on the earnings outlook of growth sectors such as Communication Services and IT. While the work-from-home initiatives are likely to ease, we still expect it to remain in the foreseeable future. Many companies have also reported increased demand (for IT-related product and services) and a likelihood that the elevated demand will remain sticky. This is evident in the IT and Communication Services sectors’ continuous strong EPS growth.
Therefore, with major constituent sectors of the S&P500 likely to see continued growth momentum (e.g. IT, Consumer Discretionary, Financials), as well as a broadening out of earnings growth seen above, we think that these factors will likely reinforce the US earnings recovery.
Elevated P/E ratio limits upside potential
S&P500 is now trading at a P/E Ratio of 22.4X FY2021 EPS, above our designated fair P/E ratio of 20.0X. This is also higher than the 10-year historical average P/E ratio of 17.5X, or the 5-year pre-COVID (2015 – 2019) average P/E of 17.7X. This means that current valuations represent a 28% premium over the 10-year average, and a 26% premium over the 5-year pre-COVID average.
Valuations are pricing in an overly positive scenario, leaving little room for the situation to go south. We therefore see a material de-rating risk (a key risk in US equities right now) if:
- negative catalysts emerge along the way, with the main issue being tapering. The Fed has to tread very carefully with its unwinding of asset purchases, as well as potential rate hikes after – a policy misstep may trigger another ‘taper tantrum’ we witnessed in 2013;
- earnings fail to materialise in line with optimistic market expectations. Equities may re-price lower, if subsequent quarters of earnings show considerably slowing of earnings momentum.
Applying our fair P/E ratio of 20.0X on EPS projections for the next two years, we project a target price of 4,850 for S&P500 Index by end-2023. This represents only a +7% upside potential from yesterday’s closing price (4,523 on 31 Aug 2021) over the next 2+ years.
Chart 4: S&P500 P/E ratios
Conclusion: Earnings are good, but much has already been priced in
In sum, Q2 earnings were solid and remain strong relative to history. There are also signs of the recovery becoming more broad-based. On an individual sector level, pro-cyclical industries like Financials, Consumer Discretionary, and Communications continue to lead the pack, but other sectors are also improving.
We think that earnings growth should remain robust in Q3/Q4 and even beyond. This should be supportive of the US equity market. However, we believe much of it has been baked in equity prices, as implied by the sky-high valuations. We remain cautious as the risk of de-rating remains material. That said, we believe opportunities still lie in the US equity market and it definitely pays to be selective.
Chart 5: S&P500 Price Performance and EPS
Table 1: S&P500 Projection 2021 – 2023
| US S&P500 Index | FY20 | FY21 | FY22 | FY23 |
| PE Ratio (X) | 27.0 | 22.3 | 20.5 | 18.7 |
| Expected Earnings Growth YoY | -15% | 46% | 9% | 10% |
| Earnings Per Share (EPS) | 139 | 203 | 221 | 243 |
| Projected Fair Price (based on fair P/E Ratio of 20.0X) | – | – | – | 4,850 |
| Potential Upside from Today (%) | – | – | – | 7% |
| Source: Bloomberg Finance L.P., iFAST estimates. Data as of 3 Sep 2021. |
Table 2: Recommended product(s) for US equities
| Unit Trust | ETF | |
| USA | JPMorgan Funds – US Small Cap Growth A (dist) USD Wells Fargo US Large Cap Growth Fund Cl A Acc USD | Vanguard S&P 500 ETF |