US Q3 reporting preview: can earnings season revive the S&P 500?

“Earnings from PepsiCo on Wednesday, Walgreen Boots Alliance and Delta Airlines on Thursday, and then a slew of megabanks on Friday, kick-off the third-quarter results season in the USA and wobbling stock markets will be looking for reassurance that corporate profits are holding up,” says AJ Bell Investment Director Russ Mould.

“After recent stink-bombs from Nike, Seagate, Micron, AMD and Hasbro, to name but five, such reassurance may be hard to find and analysts’ overall profit forecasts for the S&P 500 continue to fall.

“Bears will growl that the combination of falling profit forecasts, rising interest rates and still-lofty valuations mean that US equity market remains exposed on the downside, especially after the bubbly romp of 2020-2021 – and the S&P 500 still stands 8% above its February 2020 pre-pandemic peak, even after 2022’s year-to-date 24% slump.

“Bulls will reply that analysts are already up to speed and that earnings cuts lessen the scope for further nasty surprises. Research from Standard & Poor’s shows that US firms have beaten quarterly estimates 73% of the time since Q1 2013 and missed just 20%, although this may be as much down to careful expectation management as underlying strength in demand.

“The downgrades for Q3 may be academic anyway if company guidance for Q4 is bearish and the outlook statements, assuming management feel able to give any in the prevailing environment, could be more important than the reported quarterly figures.

“According to research from Standard & Poor’s, aggregate earnings per share (EPS) estimates for the third quarter for the S&P 500 have fallen 8% since June. Estimates for Q4 have slipped as well and full-year numbers for 2022 and 2023 have been downgraded by 7% and 4% over the past three months.

“Standard & Poor’s research is now suggesting that third quarter EPS will rise 6% year-on-year and that Q4 will come in flat, to leave 2022 overall unchanged in 2021.

“That’s not necessarily the sort of momentum that generates bull markets and anyone still keen to buy on the dips will be putting a good degree of faith in forecasts of a 15% rebound in S&P 500 earnings per share in 2023.

Source: S&P Global

“How credible those forecasts are at a time of an apparent economic slowdown, rising input costs (including energy and wages) and higher borrowing costs, remains to be seen. Profit margins are already cracking, and the environment does not seem conducive to further improvement from near-record highs, even allowing for US firms’ well-known ruthlessness when it comes to cutting costs (and staff) when times get tough.

Source: S&P Global

“US corporate profits already stand at an all-time high as a percentage of GDP, too. You would expect higher wages to take away of a chunk of that, if nothing else, so forecasts of a further rise in US earnings at first glance seem optimistic, even allowing for how inflation could bloat the numbers in nominal terms.

Source: FRED – St. Louis Federal Reserve database

“Equally, it may not matter as much as you might think. Markets are already on a state of high alert as they await a pause and then pivot in US Federal Reserve monetary policy.

“Last week, stock markets moved to shrug off ructions in the credit markets and worries over Credit Suisse. Instead, they latched onto a lower-than-expected increase in interest rates from the Reserve Bank of Australia, a drop in US job vacancies and weak new orders in the latest American purchasing managers’ index (PMI) for manufacturing as early signs that the break-neck speed in monetary policy tightening may be about to slow.

“That prompted an upward pop in share prices and risk assets around the world. Even if it proved short-lived, that surge showed what might happen if we do get a pause and pivot.

“If central banks do slow, pause, and finally reverse rate rises, they would be potentially leaving us to take our chances with inflation. That in turn could prompt a dash to ‘hard’ assets, or at least paper claims on them through shareholdings.

“But the intervening period is likely to be a volatile one and investors may need to proceed with caution before they see the next leg up in share prices, especially if central banks show more backbone than markets currently anticipate, because on many metrics US stock markets still look expensive relative to their history.

“At 3,640, the S&P 500 looks to trade around 17.5 times earnings for 2022 and 15 times for 2023. Neither is outlandish relative to US equity markets’ recent history, although that 2023 prospective multiple does reply upon the forecast of 15% earnings growth.

“Less encouraging is Professor Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio, which does not rely on forecasts but rolling ten-year average historic earnings, adjusted for inflation

Source: online data Robert Shiller

“By the professor’s own admission, CAPE is not a tool for timing markets. But on the previous, rare occasions when the CAPE ratio has stood at the current 29 times, subsequent ten-year compound returns from US equities have invariably been negative, which is something that long-term investors might need to consider.”

These articles are for information purposes only and are not a personal recommendation or advice.