Bracing for Earnings

After months of broader economic worries, investors are about to narrow their focus to corporate fundamentals.

In recent years, quarterly earnings seasons have usually provided a positive reminder about corporate health. Even in the face of inflation, corporate profit margins held up well.

That could be about to change. While energy companies are still forecast to post expanding margins from a year ago, every other sector is likely to see compressed margins, according to FactSet. Based on the consensus Wall Street estimates, FactSet forecasts the S&P 500's second-quarter net margin at 12.4%, below the year-ago figure of 13.1%.

"In our view, this could be one of the more influential earnings seasons since the depths of the pandemic," Ameriprise Global Market Strategist Anthony Saglimbene wrote today. While stocks haven't exactly had a banner year, earnings reports in the first quarter were one of the few positives, he notes. Here's more from Saglimbene: 

Strong demand and the ability to protect profit margins were key dynamics several U.S. companies pointed to in Q1, which helped S&P 500 companies to surpass first quarter estimates by a meaningful amount. And while that development didn’t really help stock prices over the previous earnings season, we would argue stock declines may have been worse in the second quarter if not for companies' continued ability to hurdle above analyst profit estimates. But as recession odds in the U.S. and abroad have grown and cooling demand is now a top-of-mind concern for investors, what companies have to say about their business outlooks over the coming weeks should take on an added degree of significance.

All told, analysts are expecting overall S&P 500 earnings growth of 4.3% in the second quarter. That would be the lowest figure since the last quarter of 2020, when the economy was just beginning to recover from pandemic quarantines. 

To be sure, investors have been bracing for the slowdown. And that's a big reason why the S&P 500 is down 19% this year. The S&P 500 currently trades at just 16.3 times expected earnings for the next 12 months.  A year ago, heading into earnings season, the P/E was 21.4. Earnings have continued to grow over the last year, so it's that multiple compression that explains stocks' big losses. Investors are paying less for every dollar of earnings. 

There are lots of factors to blame for the weakening sentiment, most notably rate hikes. The next round of earnings reports will go a long way in determining how much weaker the sentiment gets.