The focus in the Q1 earnings season lately has been on the Retail sector, particularly the department store space, with every notable industry player coming out with disappointing results. Macy’s (M - Analyst Report) started the parade of disappointing results, but was quickly followed by every type of department store, irrespective of their target market.

Apparel is apparently the weakest category for these operators, with management teams appearing clueless as to what has happened to apparel demand. But that’s hardly the only issue facing these operators – they are dealing with a secular shift in consumer preferences, with consumers increasingly comfortable spending their money online at Amazon (AMZN - Analyst Report) instead of going to the mall. It isn’t a consumer spending issue, it is more tied to evolving consumer spending habits. In other words, the question isn’t how much consumers are spending, but where they are spending it.

The proof of this came in the largely positive monthly April Retail Sales report, with the report’s internals showing a lot of momentum. Of particularly relevance to the disappointing earnings results from the department stores lately, the April Retail Sales report’s sub-category about non-store retailers (includes operators like Amazon and other on-line and catalog vendors) had the strongest gain of all categories. What this means is that consumer spending is steadily shifting from the traditional avenues to online platforms.

These traditional retailers likely still have plenty of pain to endure, but they can start putting their house in order by aligning their businesses with evolving consumer preferences. It is hard to envision the industry surviving in its current format given Amazon’s operating momentum.

Retail Sector’s Q1 Scorecard

A number of major retailers like Wal-Mart (WMT - Analyst Report), Target (TGT -Analyst Report), Home Depot (HD - Analyst Report) and others are on the docket to report results this week, but we have already seen Q1 results from 55.8% of the Retailers is in the S&P 500 index. Total earnings for these retailers are up +3.2% from the same period last year on +9.7% higher revenues, with 75% beating EPS estimates and 50% beating revenue expectations.

Positive surprises are more numerous even for the Retail sector, as you can see in the right-hand side chart below.  

The growth picture emerging from the left-hand side chart doesn’t look so bad, with earnings growth in positive territory and revenue gains tracking above historical periods. But a lot of that momentum is a function of non-department store results that came out earlier in this cycle, particularly from online vendors like Amazon. The sector’s growth comparisons don’t look so good on an ex-Amazon basis, as the right-hand side chart below does.

Overall Take on the Q1 Earnings Season

We have been pointing out these trends since the start of this reporting cycle, which include widespread growth challenges, more numerous positive surprises and fewer negative revisions to current-quarter estimates. The abundance of positive surprises is primarily a function of the levels to which estimates had fallen ahead of the start of this reporting cycle. The recent pullback in the exchange value of the U.S. dollar is likely helping on the margin side as well, though low expectations made all the difference.

The more notable development on the earnings front is the deceleration in negative estimate revisions to current-period estimates (estimates for 2016 Q2). While estimates for Q2 are coming down, following the well-trodden path of previous quarters, as the chart below depicting evolution of Q2 estimates shows.

As negative as this revisions trend looks, it is nevertheless an improvement over what we had seen in the comparable period in the preceding earnings cycle. The improved commodity-price backdrop and the reduced dollar drag are some of the more plausible explanations for this development. But it is also likely that Q2 estimates had already fallen enough at the time when Q1 estimates were coming down and there is simply not that much need for further downward adjustments.

Whatever the reason for the lower negative revisions trend for Q2 estimates, it is nevertheless a potentially positive development, particularly if sustained over the coming months. We will have to wait till July to get a better read on this development after companies start reporting June quarter results and guide towards Q3 estimates. Current estimates for Q3 are showing essentially flat growth from the year-earlier level.

Q1 Earnings Scorecard (As of Friday, May 13th)

We now have Q1 results from 459 S&P 500 members or 91.8% of the index’s total membership. Total earnings for these index members are down -7.3% from the same period last year on -1.4% lower revenues, with 71.0% beating EPS estimates and 55.3% beating revenue estimates. The percentage of companies that are able to beat both EPS and revenue estimates is tracking 45.8% at this stage.

The table below shows the current scorecard for these companies

As you can see (columns 2 & 3), the Q1 earnings season has come to an end for 10 of the 16 Zacks sectors, while another 3 sectors are past the 90% mark in their reporting tallies. The Retail sector has the most still to come at this stage with only 55.8% reported so far.

The last column of the above table, titled ‘price impact’, shows the average price impact of the earnings releases. The most positive reaction has been to the Transportation, Utilities, Construction and Consumer Staples sectors while the reaction to the Tech sector results has been the most negative of the major sectors.

The charts below compare the results thus far with what we have been seeing from the same group of 459 index members in other recent periods.

As referred to earlier, the two key takeaways from the results thus far are:

First

The growth challenge is not only very obvious, but also widespread. The Energy sector is no doubt dragging the reported growth pace quite a bit, but the growth comparison still remains unfavorable even if we exclude the reported Energy sector reports from the sample of reported results. The right-hand side chart below presents the growth picture on an ex-Energy basis.

Second

Positive surprises are more numerous, particularly on the revenues side. The big driver of this is the low levels to which estimates had fallen ahead of the start of this earnings season. But as indicated earlier, the improving dollar is helping matters to some extent as well.

This incidence of more numerous positive surprises is visible in the ‘blended’ beats comparisons as well; ‘blended beats’ refer to companies that beat both revenues as well EPS estimates. At present, 45.8% of the 459 S&P 500 members that have reported results are beating both EPS and revenue estimates, which is better than what we saw from the same group of companies in the preceding quarter as well as the 4-quarter and 12-quarter averages.

Even the beleaguered Basic Materials and Industrial Products sectors have beat EPS and revenue estimates more often this time around compared to other recent periods. The proportion of Basic Material sector companies that have beat both EPS and revenue estimates in Q1 is 35.0%, which compares to 4-quarter and 12-quarter averages of 10% and 22.1%, respectively. The highest blended beat % are for the Construction, Conglomerates, and Aerospace sectors while the lowest is for Utilities.

Tech Sector Results

Market participants found the Tech sector’s Q1 earnings performance to be disappointing, with a number of the bellwethers like Google’s parent 

Alphabet (GOOG), Apple (AAPL) and others coming up short of estimates in their results and/or guidance.

Including all of the Tech sector reports that have come out already, we have Q1 results from 89.7% of the sector’s total market capitalization in the S&P 500 index. Total earnings for these Tech companies are down -5.6% on +0.8% higher revenues, with 70% beating EPS estimates and 52% beating revenue estimates. Excluding the Apple drag, total earnings for the rest of the sector would be up +0.8%.

This is weak performance from these Tech companies relative to what we have seen from the same group of companies in other recent periods, as the charts below show.

What this shows is that not only growth remains challenged, but fewer are able to beat expectations. In fact, positive revenue surprises are tracking more than 5 percentage points below the 4-quarter average and 10 percentage points below the 12-quarter average. Please note that the sector’s weak growth pace is primarily a function of tough comparisons at Apple. Excluding Apple, the sector’s Q1 earnings growth would be +0.8%.

Q1 Estimates As a Whole

Combining the actual results from the 459 S&P 500 members that have reported results with estimates for the still-to-come 41 members, total Q1 earnings are currently expected to be down -6.9% from the same period last year on -1.1% lower revenues. This will be the 4th quarter in a row of earnings declines for the index.

Energy is the big drag in Q1, as it has been in other recent periods, with total earnings for the sector expected to be down -107.8% from the same period last year on -31.5% lower revenues. Excluding the Energy sector, earnings growth for the remainder of the index would still be in the negative – down -1.6%. In total, 9 of the 16 Zacks sectors are on track for negative earnings growth in Q1, including Finance and Technology, the two biggest sectors in the index.

The table below presents the summary picture for 2016 Q1 contrasted with what companies actually reported in the 2015 Q4 earnings season.

The chart below shows current quarterly earnings growth expectations for the index in 2016 Q1 and the following four quarters contrasted with actual declines in the preceding three quarters. As you can see, growth is expected to be negative in 2016 Q2 and barely in positive territory in the following quarter.

Q1 is on track to be the 4th quarter in a row of earnings declines for the index. But as you can see in the chart above, this trend of earnings declines is expected to continue into the second quarter and most likely into the following one as well.