As investors ’concern about the slowdown in U.S. economic growth manifested itself in the form of falling commodity prices, while the strength of the U.S. dollar weighs on the international gains of U.S. multinationals, the analysts at Bank of America Global Research BAC, -1.04% and other retail research stores. they highlighted the following paradox: expectations of corporate earnings growth remain relatively robust, although analysts fear that inflation and tightening financial conditions could lead to a recession before the end of the year.
Given the difficult performance of U.S. equities this year, many defeated investors expect good corporate performance (at least relative to expectations) to catalyze a lasting rebound in U.S. equities. Others fear that a disappointment could wipe out one of the last supports for US equities, as corporate earnings experienced a lasting post-COVID rebound and even exceeded expectations during the first quarter of 2022.
Quarterly earnings growth expectations for the S&P 500 SPX, -1.15%, rose to 5.5% on Monday, from 5.3% a month ago, according to S&P Global Market Intelligence. According to FactSet data, earnings in the top 18 companies in the S&P 500 have been stronger than expected, but most of the business gains, including the most valuable members of the market capitalization-weighted benchmark, they are ahead.
That will start to change later this week. The “earnings season,” as analysts call it, begins Thursday with JP Morgan Chase & Co., JPM, -1.31% and a lot of reports from the largest U.S. banks. On July 29, more than 70% of S&P 500 voters will have reported their second-quarter results.
While quarterly earnings for S&P 500 companies tend to exceed expectations, FactSet noted that only meeting earnings expectations during the months of April, May, and June would leave U.S. companies with the slowest growth in profits from the fourth quarter of 2020.
Still, as investors prepare for the approaching earnings torrent, MarketWatch has compiled a summary of what some of the big investment banks are telling their clients ahead of the quarterly earnings deluge, which begins Thursday with the JP Morgan Chase & Co. reports
Read: Wall Street profit expectations for mega-banks have cooled ahead of gains amid a deep freeze on stocks
A strong dollar carries risks
Morgan Stanley’s chief financial strategist, -1.19% Michael Wilson, has received a lot of credit for correctly marking the sale of shares this year (he was also one of the most skeptical voices on Wall Street during most of the COVID rally). Looking ahead, it remains bearish, warning customers in a research note dated Monday that the strong dollar could create an unexpectedly large tailwind for second-quarter business gains.
Altogether, American companies generate about 30% of their sales abroad. A strong dollar means companies are losing money on the exchange rate, while making it increasingly expensive to hedge their risk.
“From a stock standpoint, the strength of the dollar will be a major obstacle to the profits of many large multinationals. This could not have come at a worse time, as companies are already struggling with margin pressure for cost inflation. , higher / unwanted inventories and slower demand, “wrote Wilson and his team.
Pointing to a negative correlation between the S&P 500 earnings revisions and the stronger dollar, Wilson said the math here is relatively straightforward: every dollar increase from one year to the next causes an impact of about 0.5. percentage points in EPA growth. . At the current level of 16% year-on-year, this translates into a wind against 8 percentage points, all the same.
The risks of recession skewed towards the end of the year
A group of C-led equity strategists, -1.35% of Citigroup, Scott Chronert, wrote on Friday in a note that they expect the U.S. economic landscape in the second half of 2022 to be more robust, with the risk of a more likely recession in 2023. If second-quarter gains prove to be as resilient as Citi expected, it could lead to a rebound in short-term stocks in what Citi’s team described as a “reversal” trade. average “at the end of the year.
They also argued that the rise in inflation that began about a year ago has likely helped companies ’profits, as companies can charge more for their products and services. There is also a strong correlation between corporate earnings growth and Federal Reserve interest rate hikes, with a slowdown in business profits as the central bank begins to cut rates and increase as they rise. the types.
“Difficult compositions” can also be a problem
As noted by Credit Suisse CS -3.04% Jonathan Golub, corporate earnings increased by a staggering amount during the second quarter of 2021 as global economic reopening accelerated within reach. According to FactSet, the S&P 500 EPS rose more than 90% during the second quarter of 2021. That means it will be a difficult quarter to surpass this year.
A company’s performance in each quarter is ultimately judged based on its performance during the same quarter a year ago. And last year’s second-quarter strength means companies in the S&P 500 are facing “tough compositions” this year, especially with EPA growth expected to be only 5%.
The setup looks better for the third and fourth quarters.
“Margin compression” is a threat
Another threat that corporate profits face is “margin compression,” that is, when profit margins contract, even overall sales increase. It is difficult to avoid in periods of intense inflation.
According to a team of analysts led by Goldman Sachs Group Inc. GS, -1.11% U.S. stock strategist David Kostin, is expected to see sales of S&P 500 companies grow 15% during the second quarter thanks to the momentum provided by inflation. However, higher input prices, wages and loan costs mean that profit margins are reduced by 18 basis points to 12.2%.
In addition, if the 239% increase in profits in the energy sector is excluded, the expectation is that companies’ profits will experience a contraction of 3% during 2022.
Analysts at both Bank of America and Goldman Sachs said they expected EPA growth to likely slow during the second quarter due to the strength of the dollar and the downturns in the U.S. economy.
Of course, business gains aren’t the only highlight of the economic calendar that could affect markets this week. As for inflation, the Department of Labor’s consumer price index for June will be released on Wednesday. The market will be closely monitored and while the data will not fully reflect a fall in commodity prices over the past five weeks, they could influence the Federal Reserve’s rate hike plans. In recent weeks, the expectation that the slowdown in growth will lead to a reduction in commodity prices has led both investors and economists to lower their expectations about the Fed’s hiking cycle. According to FactSet, the agreed expectation is that general inflation will rise by 8.8% year-on-year, which would be higher than the 8.6% rate recorded in May.
On Monday, US stocks traded lower, with the S&P 500 down 0.8% at 3867, the Dow Jones Industrial Average DJIA down -0.52% at 0.2% at 31271, and the Nasdaq Composite COMP, -2.26% to 1.7% in 11437. U.S. benchmark indices have fallen 18.9%, 13.9% and 19.7% so far. ‘year, respectively.