Companies are gearing up to release their third-quarter earnings reports, and while higher earnings are anticipated, experts caution against expecting a stock market surge. Despite the optimism, it’s important to note that these results may not be as impressive as some hope.
Modest Growth Forecasted
Analysts predict that aggregate sales for companies in the S&P 500 will only see a modest increase of about 1.7%, compared to the previous year’s figures. This growth rate comes as no surprise, considering that companies began reporting slowing sales growth in the third quarter of 2022.
This subdued growth indicates that the economy is not operating at its full potential. With sales projected to rise in the low single digits relative to last year’s relatively low base, it’s clear that there is room for improvement.
Margins Under Pressure
Another factor contributing to the less-than-stellar earnings outlook is the shrinking profit margins. While revenues are growing, profits are increasing at a slower pace due to rising labor costs outpacing sales growth.
Cautious Analyst Expectations
However, there is a silver lining amidst the cautious predictions. Analysts have set conservative expectations, with per-share earnings estimates for S&P 500 companies decreasing by approximately 0.1% in the past month. This provides an opportunity for potential upside surprises in the stock market.
According to Kyle Rodda, a senior market analyst at Capital.com, setting low expectations for this reporting season may lead to unexpected positive outcomes.
Early Earnings Reports Show Promise
A handful of companies have already released their earnings reports, and the results have exceeded expectations. Out of 21 companies analyzed by Wells Fargo, 18 beat estimates for earnings per share (EPS).
For instance, PepsiCo demonstrated a strong performance. Despite a slight decline in product volume sold, price increases contributed to a nearly 7% boost in total sales. Furthermore, higher-than-anticipated profit margins led to a 14% increase in EPS, surpassing initial projections.
As companies continue to announce their third-quarter earnings, it remains to be seen whether these positive surprises will be sustained across the board. Investors and analysts will be eagerly watching as the quarter unfolds.
The Challenge of Earnings Season
The current state of the stock market poses a challenge for investors as the prices already reflect a high level of optimism about earnings. Therefore, it is unlikely that the reporting season will bring about substantial gains for the S&P 500. With the index experiencing double-digit growth this year and trading at around 18 times the expected EPS for the next 12 months, compared to just under 17 times at the beginning of the year, the market appears to be expensive.
This becomes even more significant considering the rise in bond yields, which has made fixed income investments more attractive. In order for stock prices to make significant gains, earnings would have to surpass expectations by a significant margin.
Presently, companies that have reported their earnings have experienced a “mostly ‘sell-the-news'” reaction to their results. According to Chris Harvey, the chief U.S. equity strategist at Wells Fargo, shares of the 18 firms that beat estimates have underperformed the S&P 500 by an average of almost a percentage point the trading day after earnings.
Investors are realizing that past earnings only provide insight into what has already happened, and they are concerned about the weakening economy in the face of higher interest rates. Consequently, in order for a stock to experience gains after earnings, the market needs to have high confidence in a company’s profit outlook. This aspect is especially crucial considering the high valuation of many companies in the market.
Looking ahead, market watchers believe that the most interesting details will be found in company guidance for 2024 and whether they can meet the market’s lofty expectations.
This week, several companies are scheduled to release their earnings results, including Delta Air Lines, Domino’s Pizza, Fastenal, JPMorgan Chase, Citigroup, and others.
However, it is important to note that this earnings season is unlikely to propel the stock market to new record highs.
