Non-Financial Profits Down, Defensives Up

With 314 first-quarter earnings releases already published, we have sufficient data to begin to draw some intelligent conclusions about the U.S. earnings season, which, by any measure, is the most important driver of global equity markets. Today, we will analyse net income figures and will follow up tomorrow with an analysis of revenue and then cash flow on Thursday.

Non-financial profits declines year-over-year, defensive sectors are the bright spot
The U.S. earnings season has so far been similar to its predecessors with a high earnings surprise ratio of approximately 75 percent. If we look at aggregate normalised net income, S&P 500 companies are showing a 0.8 percent growth year-on-year in the aggregate figures. Exclude financials, and the growth rate drops becomes a 0.6 percent contraction, highlighting the impact from better-than-expected earning releases from financials. The figures can still change, but the profit decline in non-financial companies is not looking good.

The chart below shows the aggregate change in normalised net income for the ten sectors. Many financial commentators have said that the fact that this year's rally has been driven by defensive sectors is a sign of weakness. However, as the chart shows, it is the defensive sectors that have improved their profits relatively the most. The two best sectors have been utilities and telecommunication services, with the former up almost 28 percent year-over-year.

The law of small numbers play into top 10 on profit growth
Among individual companies, small companies with low net income figures are dominating the top 10 table on profit growth. This is not a surprise given the law of small numbers, meaning that smaller companies can more easily double net income than Google or Apple.

The most interesting observation is the huge improvement in net income among home builders such as Lennar Corporation (LEN:NYSE) and D.R. Horton (DHI:NYSE) highlighting the improvements in the U.S. housing market. Another interesting company is Cabot Oil & Gas (COG:NYSE), which is an independent oil and gas company that focuses primarily on the Marcellus shale gas fields. Cabot's impressive growth in net income was driven partly by a 37 percent growth in revenue, but also increased production efficiency and economies of scale effects from its increasing production.