S&P 500 Q2 Earnings Preview
Q2 reporting gets underway – Brace Yourself for a Bleak Earning’s Season
As the second quarter of 2022 comes to an end, S&P 500 companies are being put under a microscope, and what we know so far isn’t pretty. Exiting Q1 2022, the estimated earnings growth rate for Q2 was 5.9%, however, according to FactSet’s recent report, that number had dropped down to 4.3% today. If correct, the S&P 500 will experience its lowest growth rate since Q4 2020.
S&P 500 Earnings Growth: End of Quarter estimate v.s. actual
Of the 11 sectors in the index, 7 of them are expected to report lower earnings than anticipated as of March 31st. 71 companies have already issued negative EPS guidance, while 31 companies have issued positive EPS guidance. However, it’s common to see growth estimate upside during earnings season, as “sandbagged” earnings get beat; in 39 of the last 40 quarters, the actual earnings growth rate has exceeded the estimated earnings growth rate, justifying higher multiples and prices overall. With historic differences in actual earnings and estimated earnings considered, FactSet anticipates that the S&P 500 will see a growth rate somewhere between 9% and 12% in Q2. Our thinking is that Q2 2022 might not favorably compare to the historical norm.
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Equity Sectors ranked by 6 month excess returns v.s. SPY
Market price action suggests positive outcomes for Energy, Utilities, Healthcare and Consumer Staples sectors. All of the rest are vulnerable to downside.
The energy sector is providing much of the positive lift for the index overall, with an estimated 239.1% growth target, largely due to the rising cost of oil and gas. Without the energy sector in the mix, the estimated growth rate for the S&P 500 would dip into the negatives, likely reporting a decline in earnings of 4.1%. Rebounding from 2021 dips in travel, the industrial sector can thank the airline industry for its contribution to the sector’s estimated year-over-year growth rate of 26.8%.
Offsetting the anticipated growth in the high-performing sectors, the financial sector is expected to report the largest decline of all at -23.9%. Without its influence, the S&P 500 expected growth rate would shoot up to 10.9%. The consumer discretionary sector, facing challenges with supply chain issues and economic slowdown, is the only sector expected to report a net profit margin that comes in below its 5-year average of 6.3%.
S&P 500 Banks: Provisions for loan losses projected to increase, as lenders prepare for an economic downturn
Data that we track (Market Fundamentals) shows the largest inventory build since 2010, likely pressuring retailers margins, as discounts are needed to clear merchandise.
Using forward measures, the 12-month P/E ratio is 16.3, which is below the 5-year average of 18.6 and the 10-year average of 17.0. At the close of Q1, the estimated forward 12-month P/E ratio was 19.4; this discrepancy can be attributed to the fact that prices have decreased while EPS estimates have increased in the last 3 months. Likely, the full impact of inflation, exchange rate challenges, and more, have not fully actualized yet in many of these companies. In our view, analysts will have to downgrade their EPS estimates, as they are simply too optimistic at the moment. Needless to say, a raft of downgrades during and post earnings season will not bode well for market prices. Our Market Fundamentals instrument tracks changes in EPS and trailing P/E ratios at the close of every week and will be especially important to watch during the next month.
Trailing P/E Ratios are close to the 10-year median, as only Prices have recently reverted. Earnings are yet to follow.
Median reported EPS still sitting at cycle highs and estimated to go higher by Wall Street analysts at the end of Q1.
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CONCLUSION
Since the dollar is performing strongly compared to other currencies around the world, many companies that have a multinational presence will have to decrease revenue numbers even more in Q3 due to FX adjustments. Analysts at Bank of America and Goldman Sachs have been anticipating profit margins will decrease by 18 basis points during Q2, leading to an overall slowdown in EPS growth. All of this, in conjunction with increased supplier costs due to inflation, creates challenges for H2 across most of the sectors in the S&P 500.
Although consumer spending was keeping pace for many months, allowing companies to pass higher production costs down the line, clear signs are showing that consumers can no longer keep up. According to Bank of America’s spending report, consumer spending slowed for its second consecutive month in June. It’s beginning to look like the cushion that may have been able to carry large companies through the first half of the year is getting thinner. As stimulus checks have long been depleted, people have increasingly turned to credit card debt to support spending. With the impact of increasing interest rates, that looks to have reached a limit as well.
Morgan Stanley’s Chief Investment Officer, Michael J. Wilson (known for his bearish views), anticipates the P/E ratio of the S&P 500 to fall all the way to 14 if a recession does in fact come to fruition. If true, Wilson and his team think that the S&P 500 could see a price target of 2,900 instead of their current estimate of 3,400. Wilson is just one voice in the ring discussing the future of the S&P 500, but the sentiment is echoed by many other experts as well. With Q2 earnings highlighting some massive issues in the economy right now, it seems that this is just the beginning.
Our own analysis suggests that the 12 month EPS for the S&P 500 could drop by 20% from $207 to $165. Using this assumption and the median trailing P/E ratio of 21, we get a “fair value” estimate of 3465, close to Wilson’s target, and 8% lower from yesterday’s close. A word of warning: price reversions can be brutal, and often times drop below the median level. Using the -2 Standard deviation trailing multiple of 16.75, the (very) bearish scenario could take the S&P down to 2763.
Jerica Kingsbury and Andrei Sota