Investors brace for Q2 earnings

The 2022 second quarter earnings season kick off on Thursday, with results from the major US banks, with most of the Big Tech companies set to follow in the last week of the month.

For most markets, the performance so far this year has been driven entirely by a decline in the price-to-earnings multiple as opposed to any deterioration in earnings growth expectations.  For example, the S&P 500 has declined by 18.7% so far this year in comparison to an increase in 2022 earnings growth expectations, from 8.4% at the start of the year to 9.5% according to the latest available data.  As a result, there appears to be a significant disconnect between market pricing and analyst estimate revisions.

In effect, part of the uncertainty in the market at present is related to how earnings estimates should evolve in what is shaping to be an aggressive Federal Reserve tightening cycle.  The market has a sense of what should happen to earnings estimates in this scenario but for some reason, we haven’t seen much of that just yet.

The natural order of things is that rising interest rates should take its toll on aggregate demand, causing the economy to start cooling off.  Businesses start experiencing this deterioration in the economic scenario in their normal operations, which consequently should show up in their quarterly numbers and management’s guidance.

According to FactSet, a global provider of financial information, the S&P 500 is on course to report earnings growth of 4.1% in the second quarter, which would be the slowest rate of growth since the fourth quarter of 2020.  This also marks a significant slowdown from the 9% seen in the first quarter.  Estimates have been downgraded over recent weeks and months with analysts having penciled-in 5.9% growth at the end of March.

Unsurprisingly, the energy sector is once again expected to report the strongest earnings growth in the second quarter as it reaps rewards from higher oil prices.  Similarly, miners should also see earnings flattered by improved commodity prices.  Industrials and real estate are the other two areas that markets expect to outperform the wider market, according to FactSet.

At the other end, tech shares and healthcare are forecast to deliver tepid earnings growth.  Consumer staples and discretionary are both expected to see earnings come under pressure, while utilities and financials are forecast to see the biggest bottom-line declines this quarter. 

Banks in particular are expected to face an uphill climb in a number of areas.  In fact, those with a large mortgage lending concentration like Wells Fargo and JPMorgan, are expected to suffer as originations and margins are under pressure, and lending has cooled after a stellar two years.   On the other hand, banks with a large portion of revenues coming from investment banking activities will have to deal with the current slowdown in IPO activity from Q2.  While higher rates are good in terms of interest income, if rates increase too much and infringe on economic growth, then it begins to offset any benefit and become problematic for bank growth.  One positive for banks this quarter should be the sustained high volume of equity trading and volatility, still driven by retail participation in the markets, which would benefit trading revenues. 

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018. 

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