With second-quarter earnings season now underway, investors are waiting to see whether this could be the next catalyst to send stocks even higher, or on the flip side, tumbling back to reality.
First test passed with bank earnings
As usual, big banks kicked off earnings, with JPMorgan, Wells Fargo, and Citigroup reporting last week, and market participants were looking to the group of early reporters to answer two key questions: What is the latest impact of higher rates and tightening policy on the financial system? And what will banks tell us about the strength of the consumer? Overall, these reports allayed any major concerns on these two fronts. Deposit levels at the largest banks have been stable, betas (price relative to market rates) have not risen as much as feared, and non-interest income was less bad relative to early June. On the consumer front, credit quality was also relatively benign, illustrating that while loss rates are still “normalizing,” the US consumer remains surprisingly resilient.
Despite bringing mostly good news, the overall reaction to these banks was relatively muted, likely reflecting the fact that:
1) The setup was challenging given stocks have risen sharply the past few weeks.
2) Management’s tone on conference calls was relatively muted, with most expecting more deposit pricing competition, deposit betas to rise, and the macro environment to remain uncertain.
3) Credit is still normalizing and losses could rise. So while EPS estimates may rise a bit on 2Q23 beats, upside could be limited given these factors, and we remain least preferred on the sector.
Within financials, all eyes will turn to the regional banks reporting over the next couple of weeks—which are likely to show even more deposit price competition and a cautious net interest income outlook.
The rest of 2Q and beyond
Reporting will ramp up over the next two weeks, with more than 50% of the S&P 500 market cap set to report. Zooming out from just the banks, early reporters have posted generally good results. The majority of companies are topping sales and earnings estimates, and in aggregate, earnings are beating by more than 7%. This is an encouraging sign as the early reporters have generally been a good indicator for how the rest of the season may play out. However, guidance for the third quarter is down a bit worse for the median company relative to the last reporting season, although by the time earnings season comes to a close, guidance should still be good.
Overall, we expect 2Q earnings to come in better than consensus expectations. We look for S&P 500 profits to beat expectations and decline 3–5% year-over-year, and excluding the energy sector, profits could be up slightly. Economic data in 2Q was resilient and surprised positively, and we have seen economists revise up their GDP forecasts, suggesting we should still see somewhat of a normal level of earnings beats. But while the bar for earnings season seems pretty beatable, the bigger question is whether it will be enough to represent the next spark for the market. The S&P 500 has seen one of its best pre-earnings-season performance periods since 1Q21. With valuations still quite lofty and US stocks seemingly disconnected to economic activity, we do not expect earnings to be an upside catalyst.
We believe markets will be mainly range-bound from here, with a June 2024 S&P 500 price target of 4,400. Going forward, we expect that the laggards from this year should fare better than the mega-cap growth names that have dominated the rally so far, and recommend rotating in sectors such as energy, industrials, and consumer staples.
Main contributors: Solita Marcelli, David Lefkowitz, Nadia Lovell, Matthew Tormey
Original report - What to expect from earnings season, 17 July 2023.