November 21, 2019
As the calendar third quarter earnings season winds down, it might be a good time to review outperforming and underperforming industries as well as how this might be an indicator for the rest of 2019 and into 2020. As we review small- and mid-cap stocks, more than 90% of Russell 2000 index companies have reported results. With such a large number having already reported, we reviewed Bloomberg data regarding the surprise percentage broken down by sector, which compares actual results to consensus estimates, for roughly 1,800 companies. The results were interesting to say the least.
Since the data on smaller companies can be skewed by larger earnings outliers, we chose to look at median surprise by sector to get a sense of performance from the broad range of companies within each sector. The results are presented below:
Perhaps the biggest surprise lies within the two biggest underperforming sectors, Energy and Utilities, which historically have been less likely to underperform. In the Utility sector, the biggest drivers of underperformance were a number of water utilities that significantly disappointed against earnings expectation. In the Energy sector, the lackluster performance was a bit less surprising given the recent volatility in oil and gas prices over the past several months.
The Financial sector performed well in the quarter, which should not be surprising given the shift in the Federal Reserve policy toward easing monetary policy and rate cuts which dominated the third quarter. The Fed began cutting rates in July with a second cut in September, which incidentally boosted results for smaller banks and financial institutions for the third quarter.
The Fed’s decision to cut rates was in response to slowing economic activity, which likely sheds some light in the moribund performance in Basic Materials and Industrial sectors. The slowing of these larger segments of the economy represents the drag on economic growth that has concerned the Fed and Chairman Powell.
The underperformance of the more basic segments of the economy were largely offset by the continued stronger performance in the Consumer Cyclical and Consumer Non-cyclical sectors, which continued to perform well. With consumer confidence remaining strong and consumer demand continuing to support the broader economy, this outperformance was more or less expected. The standout performance of the Technology and Communications sectors highlights the continued impact of the consumer on earnings. With wireless telecommunications, media and digital companies continuing to outperform, the merging of web-based technology with traditional communications continued to be a potent force for earnings outperformance. On the Technology sector, software, services and semiconductors drive performance with some tangential support from consumers.
The calendar third quarter was a fairly positive quarter on the earnings front despite concerns over slowing GDP growth. The majority of companies continued to post earnings well ahead of consensus expectations. Looking ahead to the fourth quarter, there are a number of considerations for the small- and mid-cap space. First, it is important to remember that earnings performance may not equate to stock performance. Recently, many analysts have discussed a shift in market preference toward value stocks from growth, but based on the outperformance of Technology in the third quarter relative to more traditionally value-focused industries like Industrial, suggests that growth companies are still performing. We might also consider the potential impact of news events or lack thereof. When considering Industrials or Consumer Cyclicals, there may be a news impact from developments in the ongoing trade negotiations with the U.S. and China. Similarly, Financials may be impacted by the recently announced pause in rate cuts by the Federal Reserve. By early 2020, we will have another quarter to ponder performance within small- and mid-caps, which will hopefully be as positive as the past quarter.
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