Not your average earnings season


Investors will need to look deeper at earnings results for possible clues about the path forward.


July 21, 2022

Kelly Bogdanova
Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.

With inflation raging, the Fed aggressively hiking interest rates, economic momentum slowing, and recession risks rising, we think the Q2 corporate earnings reporting season is of heightened importance. Earnings news in the coming days and weeks could shape the market’s near-term path and provide hints about prospects for profit growth over the medium term.

Are earnings estimates too optimistic?

S&P 500 quarterly earnings per share

S and P 500 quarterly earnings per share

Column chart showing quarterly S&P 500 earnings per share since 2019. The actual results are from Q1 2019 through Q1 2022, and the consensus estimates are from Q2 2022 through Q4 2023. Earnings rose slightly until Q4 2019 to almost $42 per share. Then they plunged in Q1 and Q2 2020 due to COVID-19, falling to a low point of roughly $28 per share. Since then, they have steadily gained, rising to almost $55 per share in Q1 2022. The consensus forecast estimates that earnings will rise this year and next, reaching $65 per share in Q4 2023.

Note: Actual earnings in dark blue, consensus estimates in light blue

Source – RBC Wealth Management, Refinitiv I/B/E/S; data as of 7/21/22

Six things to take note of during earnings season:

High earnings hurdle: The S&P 500 is facing a very challenging year-ago comparison as earnings growth surged 88 percent in Q2 2021 – by far the strongest post-COVID-19 crisis recovery quarter. This is the main reason the Q2 2022 consensus forecast of 5.7 percent growth looks tepid and is below the long-term average. But we think five percent or better growth would be respectable on top of the high hurdle from the prior year.

High-profile misses: There have already been some big misses in Q2 results and/or guidance such as those from AT&T, Baker Hughes, International Business Machines, JPMorgan Chase, and Carnival Cruise Lines. Given the unique inflation and currency headwinds, and importantly the overall deceleration in domestic and global economic momentum, we think there will be more high-profile misses. To us, this would signal the earnings cycle is maturing – at the very least.

Profit margin scrutiny: We will be closely monitoring underlying margin trends due to high raw materials, warehouse, and transport costs and because of lingering supply chain challenges and mounting wage pressures. Some companies should be able to maneuver through these headwinds by maintaining pricing power. For example, PepsiCo reported that it has successfully passed along price increases to customers. But we think other companies will fail to keep pace with higher input and wage costs. We expect margin pressures to cause some high-profile earnings misses and negative guidance.

The consensus forecast has S&P 500 profit margins declining 6.7 percent in Q2 – not bad in light of the inflationary pressures and especially considering margins were very strong a year ago. But when we strip out the Energy sector’s ultra-robust Q2 margin growth forecast of 192 percent, the S&P 500 margin estimate retreats to a less acceptable -10.3 percent.

Lower beat rates: So far, Q2 earnings and revenue beat rates are lagging prior periods. While a high proportion of companies are still exceeding consensus forecasts, the magnitude of the beats is lower than normal. The earnings surprise level – the amount by which earnings growth exceeds the consensus forecast – is pacing at 3.6 percent, below the pre-pandemic 5.2 percent average. When beat levels compress, this typically means analysts’ estimates have become loftier and more challenging to clear, and/or the earnings growth cycle is entering a later, more mature phase. We think all of these factors are at play this earnings season, and are signals the cycle is losing momentum.

Sector distortions: In any given earnings season, there are sector or industry distortions worth watching. For Q2, they are more pronounced and primarily come from Energy, Financials, and the FAANG technology-oriented stocks.

The Energy sector is expected to provide an outsized boost to S&P 500 earnings with its eye-popping 260 percent year-over-year estimated consensus earnings growth rate. The sector is benefitting greatly from high crude oil, refined product, and natural gas prices. While the overall S&P 500 earnings growth rate is pacing at 5.7 percent, if the Energy sector is excluded the rate drops to -2.5 percent.

In contrast, the Financials sector is a drag on S&P 500 earnings. Banks have an unusually difficult comparison from the year-ago period because back then they released significant COVID-19 loan-loss reserves, which resulted in very strong profit growth. Now it’s time to pay the piper. With many firms in the Financials sector having already reported Q2 results, the sector’s earnings are forecast to decline 21.2 percent year over year. S&P 500 earnings growth is pacing at 13.8 percent excluding the Financials sector, much higher than the 5.7 percent rate including the sector.

The FAANG stocks as a group – Meta Platforms (the new name for Facebook), Apple, Amazon, Netflix, and Alphabet (Google) – are forecast to post a Q2 earnings loss of 21 percent. But other tech-oriented stocks are projected to have a good quarter overall by growing five percent as a whole.

Stripping out some of the major distortions from S&P 500 earnings results can provide a better view of the underlying trends for the rest of the index, as the table illustrates.

How the earnings season is shaping up so far

S&P 500 Q2 2022 dashboard

Q2 year-over-year growth
actual and estimated thus far
Revenue Margins EPS
S&P 500 11.1% -6.7% 5.7%
Key sectors/groups
Energy 67.7% 192.0% 259.8%
Financials -3.8% -20.3% -21.2%
Tech+ 7.5% -12.9% -4.5%
FAANG 5.7% -27.8% -21.0%
Tech+ ex FAANG 9.2% -4.8% 5.0%
Estimates excluding key groups
S&P 500 ex Energy 6.5% -10.3% -2.5%
S&P 500 ex Financials 13.2% 0.0% 13.8%
S&P 500 ex Energy & Financials 8.1% -6.5% 2.2%
S&P 500 ex Tech+ 11.9% -2.0% 11.3%

Notes: The data represents those companies that have reported so far (actual results) and consensus estimates for those that have yet to report. The “Tech+” category represents technology stocks within the Information Technology sector and those that are included in other sectors. “FAANG” represents the shares of META (Facebook’s new ticker), AAPL, AMZN, NFLX, GOOGL (Alphabet Class A shares).

Source – National research correspondent, Refinitiv I/B/E/S, FactSet; data as of 7/21/22

Questionable forward estimates: Since the global financial crisis in 2008-09, we think company management teams have become more cautious with their forward earnings estimates – they have little incentive to go out on a limb. And compared to years ago, a higher proportion of companies don’t even forecast beyond the next quarter, which can be frustrating for investors. This means Wall Street industry analysts, whose estimates represent the consensus forecast, don’t have as much formal corporate guidance as they used to. And when the economy wobbles and wavers – like it is now – we think the consensus estimates become more uncertain and less useful as a guidepost.

We don’t have a lot of confidence in the consensus forecasts for coming quarters. If recession risks continue to rise, we think earnings growth for this cycle will peak soon. Whether this would occur with earnings results from Q2, Q3 or Q4 2022 or in early 2023 is difficult to gauge; we think it would depend on the timing and pace of economic deceleration. But once the peak is reached, in a recessionary environment, we think earnings growth could decline roughly 10 percent to 25 percent from the peak level, like it has surrounding prior inflationary periods as we demonstrated in last week’s missive.

Because of the economic and earnings vulnerabilities, we would take the quarterly consensus estimates shown in the chart above and the corresponding full-year 2022 and 2023 consensus forecasts of US$228 and US$249 per share, respectively, with a grain of salt. The forecasts call for steady growth, but surrounding a recession, we think profits would retreat. The rest of the Q2 earnings season may provide hints as to how the future earnings path could play out.

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Kelly Bogdanova

Vice President, Portfolio Analyst
Portfolio Advisory Group – U.S.

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