Earnings at the half: Second quarter is the trough quarter, and the second half looks strong. At the halfway point for second quarter earnings, the feared recession and earnings apocalypse has faded away as the soft landing is now consensus. But there are several issues facing investors in the second half. The second quarter is the bottom for earnings The second quarter is expected to see earnings decline 6.8% from a year ago, according to Refinitiv. This is expected to be the “trough” for this earnings cycle. Estimate for the rest of 2023 and into 2024 are all notably higher. S & P 500 (dollar estimates) Q1: $53.08 Q2: $52.25 Q3: $55.46 Q4: $57.37 Q1 24: $57.36 Q2 24: $59.72 Source: Refinitiv Consumer discretionary, communication services, and industrials are all expected to see an increase in earnings this quarter, while information technology is flat. Declines are expected for commodity-based sectors like energy and materials, and for health care, where a big charge from Merck has dropped estimates for that sector. So far, results are slightly better than expected With the S & P 500 up 18% this year, skeptics have been saying that earnings are going to have to come in stronger than historical expectations to really move the needle. The results, so far, are modestly above expectations. About 80% of the companies are beating earnings estimates, slightly higher than the historic average. The average beat is 6.4%, above the prior four-quarter average of 4.2% and above the long-term surprise rate of 4.1%, according to Refinitiv. One notable negative trend: revenues. They are also lower than last year, and only 64% are beating revenue estimates. “It may be partially attributable to pricing power and how that cannot last forever,” Tajinder Dhillon, Senior Research Analyst at Refinitiv, told me. What matters for prices is forward profit estimates The stock market is a discounting mechanism for a future stream of dividends and earnings (which are potential dividends). What matters for stock prices are how the estimates for future earnings are changing. That’s why investors pay more attention to guidance (which is forward-looking) than to reported results (which are backward-looking). Investors are always asking: is the earnings trend up, down, or sideways? For the S & P 500, the overall earnings trend this year has been that estimates started higher in the beginning of the year, but have been coming down (this is typical). The good news is that after coming down in the first half of the year, estimates have stopped dropping. “2023 estimates rapidly declined from June 2022-April 2023, after which it has been fairly stable,” Dhillon told me. This is a change in trend: the trend is no longer “down.” S & P 500 (Q3 earnings) Today: Up 1.0% July 1: up 1.3% April 1: up 2.8% Jan. 1: up 5.5% Source: Refinitiv Tech: How long can tech bulls ride the “AI is going to change everything” story? The AI revolution was the big story in the first half of 2022, and a small number of stocks drove up the S & P 500. Many think the story is starting to play out, but Dan Ives from Wedbush has been bullish (and right) all year on the AI story. He says it continues for the rest of the year, and that the benefits will broaden out to include other companies. “We believe the backdrop is a risk on environment with tech leading this market higher,” he said in a recent note to clients. “Big Tech earnings has been a flex the muscles moment for the bulls and the fundamental growth stories are now inflecting into 2H23 and 2024 with an improving backdrop and the AI Revolution just starting to kick in.” Is “disinflation” a story for the second half? There’s been lots of reports about lower volumes from companies like Dow, MMM and Kimberly-Clark. Some are able to keep raising prices but others, like Whirlpool and Dow, are having pricing challenges. This is creating some margin pressure, and some companies have begun talking about cost cutting. But for the moment, that is a story for later in the quarter, and the year.
