Macro Intelligence: US earnings Q2 season preview

In this week’s Macro Intelligence, we preview the Q2 reporting season, highlight the key themes to watch, assess the market’s fundamentals, and analyse the charts of three US indices.

S&P 500 earnings expected to contract in Q2

Analysts are forecasting another contraction in earnings for the second quarter, marking the third successive quarter of negative earnings growth for the market. Aggregate EPS for the S&P 500 is forecast to decline by -7.2%, forecasters downgrading expected earnings as the reporting period approaches.

The commodity-sensitive materials and energy sectors are tipped to post the biggest contraction of 31.4% and 48.3%, respectively. Healthcare and information technology are also expected to deliver negative earnings growth.

S&P 500 earnings growth chart

Surprisingly, analysts estimate relatively resilient corporate profits for the calendar year despite fears macroeconomic conditions may deteriorate further.

FactSet’s figures suggest EPS will be slightly higher in 2023 than in 2022 and approximately 12% higher in 2024. This would suggest that equity analysts are pricing in a probable soft landing in US stocks, with risks skewed to the downside and scope for disappointment regarding company guidance.

Bottom-up EPS actuals and estimates

Valuations stretched amidst narrow breadth

The S&P 500 has delivered a strong and unexpected 15% return so far in 2023, defying the bearish expectations going into the year. Crossing the halfway point of the year and entering the reporting period, the question is whether this strong performance can be sustained in the final half of the year.

Many call the S&P 500’s trend higher a ‘hated rally’, a move higher in the market that comes despite ostensibly unfavourable fundamentals.

There are two knocks on the market right now. The first is its relatively stretched valuations. Although far from the elevated levels experience during the post-pandemic “everything bubble”, the trailing price-to-earnings ratio is historically elevated. This is despite tepid earnings and rising interest rates, which could compress earnings multiples.

The second major criticism of the market is the narrowness of the rally. Although the cap-weighted S&P 500 is up by around 15% in 2023, the equal weight index is up a more modest 4-5%. When stripping out the top seven stocks in the market, the colloquially known S&P 493 is practically flat.

This phenomenon has been driven by the significant growth of mega-cap tech stocks which have surged amidst optimism about the apparently huge growth generated by artificial intelligence.

Three major themes of this earning season

• The growth outlook

With analysts forecasting an emerging recovery in earnings growth, commentary from corporates will be crucial to gauge whether these expectations are shared. Macroeconomic forecasters and even the US Federal Reserve suggest a technical recession is likely in the US in the short term.

Although an earnings recession has technically already occurred on Wall Street, forward earnings imply an actual economic contraction will be avoided.

• Margins and cost pressures

Profit margins have stayed relatively elevated even as earnings growth slowed, with companies exhibiting an ability to pass on increased costs to consumers. FactSet data suggests margins were likely eroded in Q2, despite generally lower input costs, as demand cooled in several areas of the economy.

Ongoing strength in margins will boost the case for resilient profits going forward. However, it may also fuel debate over more aggressive tightening from policymakers if it signals stubborn price pressures.

• The artificial intelligence hype

As already discussed, the rally in US equities has been driven by a narrow set of very large technology companies that could benefit from the anticipated growth in artificial intelligence. Although the sector does not encompass many of these companies, the forward price-to-earnings ratio of information technology stocks is at a rich premium to long-term averages.

Investors will also search for signs that companies are already incorporating AI into their businesses and gauging its tangible impacts (if any) on profitability.

Three markets to watch

• S&P 500

The S&P 500 is trading in a short-term up trend. However, momentum to the upside appears to be fading.

The weekly RSI is not yet overbought, suggesting in the bigger picture, a continued trend higher is possible. Resistance might be found at trend line resistance or resistance at 4550. Support may be found at 4290.

S&P 500 weekly chart

• NASDAQ

Momentum appears to be slowing on Wall Street’s tech-driven rally.

Bearish divergence is emerging on the weekly RSI as the market runs into resistance at 15,300. A break of that level could open a push to all-time highs. Previous resistance around 13,700, which coincides with the 20-week moving average, could draw in dip buyers.

NASDAQ weekly chart

• FANG+ Index

The daily charts are indicating short-term weakness for the NYSE FANG+ Index.

The trend remains to the upside. However, the price is slipping below the 20-day moving average, suggesting a possible pullback is in play. The key downside level is just below 7500. The next level to the upside to watch is all-time highs at 8050.

FANG+ Index daily chart