At Q2’s close, analysts tracked by FactSet expected US earnings and sales to fall, with many presuming this posed a reality check for its stock market in commentary we read.[i] But with nearly all America’s S&P 500 companies reporting, a couple things seem worth noting, in our view: First, just a few sectors are responsible for the S&P 500’s year-over-year earnings decline.[ii] Second, revenues bucked expectations and continued rising overall.[iii] To us, this doesn’t say anything about Q3 or beyond, but we do think it shows reality is better than most anticipated.
With 460 S&P 500 companies reporting through Friday, blended Q2 earnings (combining actual results and remaining estimates) fell -5.0% y/y, whilst blended sales rose 0.7%—both above quarter-end expectations of -7.0% and -0.4%, respectively.[iv] Although a majority of companies typically top earnings estimates, Q2’s 80% beating expectations so far exceeds the 1-, 5- and 10-year averages.[v]
As Exhibit 1 shows, even as earnings declined the last few quarters, sales didn’t, a prominent feature of this cycle, in our view. The three sequential year-over-year earnings drops through Q2 have many commentators we follow calling this stretch an earnings recession.[vi] Some of them also compare this to America’s five-quarter earnings recession that ended in Q2 2016, which—like this one—didn’t come with a broader economic recession (as of yet; a recession is when the economy contracts over a prolonged period).[vii] That earnings downturn then was Energy-driven, too (more on this later).[viii] Though US stocks never entered a bear market (fundamentally driven equity market decline exceeding -20%) then, they did fall somewhat from mid-2015 to early-2016.[ix] Notably, they troughed in February 2016 before earnings did in Q4, anticipating a profit rebound, in our view.[x] We see stocks’ October trough in US dollars this time similarly.[xi]
Exhibit 1: S&P 500 Earnings Dipped, but Sales at All-Time Highs
Source: FactSet, as of 11/8/2023.
Bolstering this optimism, in our view: Sales never stalled like they did in 2015 – 2016.[xii] Typically during recessions, we find revenues drop as this more directly reflects economic activity than profits, which can reflect everything from inflation to cost cuts to tax changes and more. This doesn’t say much about the future, but it can help explain why stocks moved on quickly from earlier recession talk.
Reality also seems better to us than headline results imply, as the Energy and Materials sectors skew Q2 S&P 500 earnings lower. These two sectors’ profits shrank by around a half and a third, respectively. (Exhibit 2) But we don’t think this is surprising with commodity prices down big from last year, as Energy and Materials firms’ profits tend to be more price-sensitive than production-volume sensitive, based on our research. For Energy, as FactSet noted: “Lower year-over-year oil prices are contributing to the year-over-year decrease in earnings for this sector, as the average price of oil in Q2 2023 ($73.56) was 32% below the average price for oil in Q2 2022 ($108.52).”[xiii] Energy’s earnings decline detracted -6.7 percentage points and Materials’ -1.2.[xiv] Excluding Energy and Materials, Q2 earnings rose 2.9% y/y—not particularly great perhaps, but far better than what surface-level coverage we see suggests.[xv]
Exhibit 2: Energy and Materials Skewing US Earnings Lower
Source: FactSet, as of 11/8/2023.
Now, almost halfway through Q3, we find all this is rather backward looking for stocks, which are pricing in earnings conditions over the next 3 to 30 months. On that front, analysts we follow are pencilling in a recovery with earnings growth expected to accelerate in the second half and into next year. We think the current bull market reflects an improving outlook. In our view, last year’s bear market pre-priced the current string of negative earning quarters, but since last fall, stocks have been looking forward to better times ahead.
[i] Source: FactSet, as of 30/6/2023. Statement based on consensus forecasts published in FactSet’s Earnings Insight newsletter.
[ii] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 sector earnings, Q2 2023.
[iii] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 revenues, Q2 2023.
[iv] Source: FactSet, as of 11/8/2023.
[v] Source: FactSet, as of 11/8/2023.
[vi] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 sector earnings, Q4 2022 – Q2 2023.
[vii] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 earnings, Q1 2015 – Q2 2016.
[viii] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 sector earnings, Q1 2015 – Q2 2016.
[ix] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 price returns, 20/7/2015 – 11/2/2016. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
[x] Ibid. Statement based on S&P 500 earnings, Q4 2016.
[xi] Ibid. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
[xii] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 revenues, Q4 2022 – Q2 2023.
[xiii] Source: FactSet Earnings Insight, as of 4/8/2023.
[xiv] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 Energy and Materials contribution to earnings, Q2 2023.
[xv] Source: FactSet, as of 11/8/2023. Statement based on S&P 500 earnings excluding Energy and Materials, Q2 2023.
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