Weak Q1 earnings growth pressures S&P 500

Earnings growth slows dramatically

First quarter (Q1) reporting season saw a 9% rise in earnings for the period, which was better than many had feared.

It was, however, the lowest rate since the final quarter of 2020, marking a distinct deceleration in performance.

As we look ahead to the impending second quarter earnings season, we should note that the overall macro outlook has not improved, and indeed appears to be worsening. Inflation remains strong, interest rates are rising and US consumer confidence recently hit a sixteen-month low.

Earnings expectations have been trimmed, but if further weakness occurs then investors should be prepared for another tough summer for stock markets, and not just in the US.

Inflation concerns soar

As the chart below from FactSet shows, inflation concerns have exploded in recent months. Unsurprisingly, inflation was not a major topic during the pandemic, when bigger worries about a global shutdown and the hit to demand from this were the big issues.

But the reopening of the global economy and the surge in demand meant that, from the third quarter(Q3) of 2020, inflation mentions began to rise again.

This trend has continued at a steady rate since then, and overall mentions have gone from a low of 57 on earnings calls to a high of 406 for Q1 2022.

Supply chain worries have eased at least, although these are still much higher than in late 2020, which might suggest that inflation concerns could drop back as we move into the Q3 and Q4 reporting periods.

Oil’s surge helps the energy sector

The big winner for Q1 was the energy sector, which reported a remarkable 268% growth in earnings compared to a year earlier. Revenue rose by an impressive 60% as well, thanks to the rise in oil and natural gas prices prompted by the war in Ukraine.

By contrast, consumer discretionary stocks suffered a 32% fall in earnings, although revenues were up by 9%. Margins have taken a hit here as companies attempt to maintain customer loyalty by cutting prices.

In addition, inflation has pushed up the prices of goods, and margins have been compressed from this direction too, with firms opting to bear the cost increases at least in part rather than pass them on to the consumer and risk losing business.

Are earnings expectations too high?

Recent data suggests that, while second quarter (Q2) earnings forecasts have been trimmed as a result of Q1’s less-than-stellar performance, expectations for Q3 and Q4 have either remained steady or have risen. Earnings for 2022 are, according to Refinitiv, expected to rise by 9.6%, up from 8.8% in April and 8.4% at the start of the year.

In part this is due to the expectation that inflation will abate to an extent as the year goes on. But price growth remains well above central bank targets, which suggests that even if consumer price index (CPI) growth slows, rates will continue to rise, pressuring consumer spending yet further.

S&P 500 outlook

Lower highs and lower lows have been the order of the day for the S&P 500 since the end of 2021, a process that has intensified since the end of March 2022. The most recent failure below 3950 adds to the negative outlook, and another disappointing earnings season would provide an additional reason for investors to cut back on equity allocations.

The June lows around 3640 could come under pressure soon, and then below this the September 2020 high at 3582 comes into view, followed up by the pre-pandemic high of 3397.