Posted by Kent Cullinane, Research Analyst
Thursday, July 13, 2023
Earnings season for the second quarter of 2023 kicks off this week, with some of the largest domestic banks, namely JPMorgan Chase (JPM), Wells Fargo (WFC), and Citigroup (C), reporting results on Friday. FactSet consensus estimates show Q2 earnings for the S&P 500 dropping roughly 7% when compared to a year ago, down from the nearly 2% decline in the prior quarter and significantly lower than the 5-year earnings growth average of 12%. The energy sector is projected to detract the most from growth, with consensus estimates showing a 48% decline in profits, as the significant drop in oil prices over the last year weigh meaningfully on profits. Conversely, the consumer discretionary and communications sectors are the only two sectors projected to record double-digit earnings growth (27% and 13%, respectively). Mega-capitalization (mega-cap) stocks in consumer discretionary (Amazon/AMZN) and communications services (Meta Platforms/META and Alphabet/GOOG/L) are responsible for the majority of the earnings growth in these sectors. Below is a breakdown by sector of year-over-year estimated earnings growth for Q2 2023:
Beyond the drag from the natural resource sectors, the biggest challenge for corporate America this quarter may be maintaining pricing power as inflation has fallen and cost pressures persist. We’ll be watching profit margins closely. Tightening financial conditions and a lull in capital markets activity will be a challenge for financials. And high valuations have raised the bar for mega-cap technology, so market reactions to results from the top seven market cap companies in the S&P 500 will also be very interesting to watch.
As of today, 113 constituents of the S&P 500 have issued earnings per share (EPS) guidance for the second quarter, with 67 companies issuing negative guidance and 46 companies issuing positive guidance. While the 67 (or ~60%) companies issuing negative guidance falls in-line with the prior few quarters, the 46 (or ~40%) issuing positive guidance marks the highest amount since Q3 2021, highlighting business and consumer resilience despite rising costs and restrictive monetary policy. Companies in the information technology sector make up nearly half of those issuing positive EPS guidance, strengthening their position as the top performing sector year to date. This guidance supports at least the typical amount of earnings upside for the quarter, in our view, suggesting a 2-3% earnings decline for the quarter is a reasonable expectation, consistent with average upside surprises historically,
When looking at the next two quarters (Q3 and Q4), year-over-year earnings are expected to increase 0.3% and 7.8%, respectively, bucking a trend of negative growth over the last two quarters and potentially finding a bottom in the current economic cycle. Despite the decline in earnings over the last two quarters, bottom-up EPS estimates for 2023 sit at roughly $218, a marginal decline from the year before. The chart below shows actual and estimated calendar year EPS for the S&P 500.
LPL Research’s forecast for 2023 S&P 500 EPS is $213, down slightly from 2023 levels, based on our base case expectation for a mild and short recession beginning in late 2023. As we noted in the just-released Midyear Outlook 2023: The Path Toward Stability (link: here), solid revenue growth and stable profit margins may help limit the magnitude of any earnings decline experienced this year. Looking to 2024, corporate America may get off to a slow start as recession potentially spills over. But as inflation continues to come down, helping to ease cost pressures, and economic growth potentially picks up, high-single-digit earnings growth may still be achievable. Our estimated S&P 500 EPS for 2024 is $230, up about 8% from our 2023 estimate.
Although not our base case, we recognize the possibility of a hard landing if inflation re-accelerates, prompting the Federal Reserve to get more aggressive, or we get a geopolitical shock. The first scenario looks less likely after Wednesday’s benign consumer inflation report, but we think it could send S&P 500 EPS for 2023 down to around $205.
Conversely, a “no landing” scenario (inflation eases to target levels and the U.S. economy muddles through without contracting) is also a possibility, which could prop up earnings this year.
Bottom line, while corporate America may deliver better-than-expected results this earnings season, the high bar being set by valuations suggests stocks may have a hard time adding to recent gains on the news.
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