2021 Q4 Earnings Preview:

Charging Through the Challenges

by Michael Reinking, CFA - Sr. Market Strategist
Top Takeaways
  • Q4 S&P 500 earnings are expected to increase by 21.7% YoY, the 4th consecutive quarter of >20% growth
  • 2021 Earnings ~30% above 2019 levels
  • Earnings revisions and mix of pre-announcements trending back towards historical norms
  • Margins remain resilient despite difficult operating environment
  • Capital Return Programs back at record levels
What will investors be listening for on Conference Calls?
  • The obvious overarching question which can be attached to most of the questions below:  was this impacted by omicron?
  • How did business trend throughout the quarter?
    • Did this vary across geographies?
  • Are margins being pressured by cost inflation associated with raw materials, logistics and wages?
  • Are previously announced mitigation measures continuing to work?
    • Are management teams treating cost pressures as transient, or becoming structural?
  • Are you raising prices?
    • How have previously announced price increases been tolerated by the market/consumers?
  • Were there signs that supply chain disruptions were beginning to ease during the quarter?
    • Is there any visibility when this could normalize?
  • How is the company managing inventories?
    • When do you expect inventories to be replenished?
    • Do you believe there has been a pull forward of demand as customers have been restocking?
  • How are rising interest rates affecting financing/capital decisions?
    • What does the capital return program look like on an ongoing basis?
    • Are you planning on increasing Cap-ex spending?
  • How is the company thinking about the post-pandemic workplace/workforce?
    • Are you having difficulty filling open positions or with increased absenteeism? How are you addressing these issues?
  • How are ESG issues impacting strategy?
Setting the Stage - A look back at Q4
Coming into the start of Q4 the S&P 500 was coming off its first monthly decline since January, with the S&P 500 declining just under 5% in September. There were multiple drivers of that weakness including a debt limit battle, an overseas energy crisis and China contagion concerns, but the primary driver was a move higher in interest rates amidst inflation worries and global central banks signaling they would begin removing accommodative policy (sound familiar?). Following the September Fed meeting there was a sharp steepening of the yield curve with the 10yr yield jumping about 30bps into the middle of October, before topping out ~1.65%. As rates began to pullback and the aforementioned macro concerns abated equity markets found their footing. Earnings season “officially” began in the middle of October and  the S&P 500 coincidentally (or not) embarked on an >8% rally into the beginning of November. Recouping all of the September losses and then some while closing higher in 17 of 19 trading sessions. Not even the official announcement by the Federal Reserve that it would finally begin tapering asset purchases by $15B /month could derail this rally.
Through most of November, equity markets digested those gains while hovering around all-time highs. However, there were signs that positioning was getting extreme as traders were preparing for a year-end rally. Just in time…..for the initial omicron headlines to begin circulating on Thanksgiving.  This led to the largest post-Thanksgiving volume trading session in history, a swift >10% decline in oil prices and a collapse in interest rates (10yr <1.4%). The following week as investors were struggling to handicap the impacts of this new variant Chair Powell appeared before Congress and in a seminal moment essentially proclaimed that inflation had replaced the virus as public enemy number one.  These catalysts reset positioning as traders scrambled to reduce risk.  Equities began to recover as data suggested that the current vaccines were effective against this variant and that symptoms were milder than its predecessors. In the middle of the month, the Federal Reserve announced that it would double the pace of tapering its asset purchases and signaled that it would be raising rates two/three times in 2022, the next step in the normalization of monetary policy. These steps were well telegraphed and once this announcement was out of the way the seasonal tailwinds and positioning reset helped most asset classes recoup all of the omicron related weakness. Traders were able to latch on to Santa’s sleigh into the end of the year with the S&P 500 closing out the month up just over 4%. This put a punctuation mark on Q4 gains of 10.6% and the third consecutive year of >15% gains for the index which closed at a new all-time high up ~27% for the year.   

Inside the Numbers
  • Q3 S&P 500 earnings continued to exceed estimates increasing ~40% YoY as 82% of companies beat analyst estimates by 10%
    • First quarter since Q2 of 2020 where earnings did not exceed estimates by at least 15%
  • Q4 earnings are projected to increase 21.7% YoY with revenues projected to grow 12.9%
    • 4th consecutive quarter of >20% YoY growth
    • 3rd highest YoY revenue growth rate since 2008 behind only the previous two quarters
  • 40% of companies issuing positive guidance in line with historical 5yr average of 40%
    • First quarter that more companies have issued negative guidance since Q2 of 2020
  • For a record 6th straight quarter estimates have increased since the start of the quarter (+0.8%) vs. an average 4.9% decline over the last 15yrs
    • Energy (+20.8%) and Materials (+11.4%) have seen the largest revision due to rising commodity prices
    • Consumer Discretionary (-7.6%) has largest decline
  • Capital return programs
    • According to S&P Global S&P 500 Q3 buybacks were up 18% QoQ to $234.6B
      • in Q3 309 companies repurchased >$5mlup from 294 in the previous quarter (371 companies did buyback stock)
    • Q3 S&P 500 dividends up 5.4% QoQ to record $130B
    • Total shareholder returns increased 13.2% QoQ to a record $364.7B (prior record was Q4 2018 $342.8B)
The Big Picture
2021 earnings are expected to rebound ~45% from 2020 levels. The fact that 2021 earnings are 25% above pre-pandemic levels is even more impressive. The resilience of corporate earnings has far exceeded even the most bullish of forecasts coming out of this crisis. In Q2, pricing power and strong demand more than offset the rising cost environment. In fact, net margins hit a record high of 13.1%. Ahead of Q3 earnings the doubts as to whether this could continue began to creep in as the operating environment remained extraordinarily challenging. The analyst community was convinced that management teams would not be able to outpace these costs and earnings/margin estimates started to move lower just ahead of the reporting season. However, a combination of strong demand, price increases and successful cost mitigation measures once again helped companies to beat estimates; 82% of companies exceeded earnings estimates by an average of 10%. Those metrics are impressive, but it was the first time that the average beat was not at least 15% since Q2 of 2020 and likely a precursor of things to come.
The setup heading into Q4 earnings is very similar. The operating environment remained challenging again though there were some signs that supply chain issues were dissipating before omicron hit. Auto makers were ramping up production as semiconductors were becoming more readily available, Vietnam factories were brought back online and port congestion was starting to ease. However, the emergence of omicron at the end of the quarter has threatened to derail any of the progress that was being made. By all accounts the demand side of the equation has remained strong. Once again the street is looking for margins to drop from 12.9% in Q3 to 11.9% in Q4. Interestingly, the calls for this to happen are not quite as loud as they have been over the past two quarters which may signal fatigue of fighting the trend. Estimated margin of 11.9% is still well above the 5yr average of 11%.
The other difference heading into the quarter is that this is the first quarter since Q2 2020 where negative pre-announcements have outpaced positive ones. This has caused the earnings revisions to slow from what we’ve become accustomed to over the last year. From the end of Q3 estimates have moved higher by 0.8%. This is a record 6th straight quarter where this dynamic has occurred. However, over the past 15 years earnings revisions from the start of the quarter have averaged a 4.9% decline. This highlights one of the key hurdles equity markets will need to overcome this year.
As we are moving to a more normalized environment, growth rates will begin to slow as the year over year comps get more difficult. To highlight this analysts expect Q1 earnings to grow 6% YoY which follows ~53% growth in 2021. Q2 will represent the toughest comp which was up ~93%. Earnings estimates for 2022 call for an increase of 9%.  While this is a strong number it clearly is a downshift from the 2021 levels. Positive earnings revisions were a key driver of returns in 2021. From the start of the year S&P 500 earnings were revised higher by 26% which coincidentally (or not again) is pretty much in line with the S&P returns. As monetary policy begins to normalize in 2022 and liquidity is withdrawn from the system multiples will continue to contract,  meaning corporate profitability will be an even larger determinant of equity returns going forward.
Data compliments of FactSet Earnings Insight as of January 7
  • Q4 earnings expected to grow by 21.7% YoY
    • 9 of 11 sectors are expected to report earnings growth
    • 2 sectors expected to grow by >20%**: Industrials (+108%),Materials (+60.9%),
      • **Energy goes from $0.1B loss to ~$28B profit
    • 2 sectors with EPS declines: Utilities (-3.4%), Financials (-0.6%)
  • Q4 YoY Revenue is expected to grow 12.9% YoY
    • All sectors are expected to report revenue increases
      • 3 sectors with revenue growth >15%: Energy (+66.9%), Materials (+24.6%), REITS (+15%)
      • 3 sectors with revenue growth <10%: Utilities (+2.5%), Consumer Staples (+4.6%), Financials (+5.9%)
  • YoY Earnings growth rates start to look more normalized in Q1 +6.3%
    • 2021 EPS estimates: +45.2%, Revenues +15.9%
    • 2022 EPS estimates: +9.4%, Revenues +7.6%
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