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Looking Ahead to Q3 Earnings Amid Persistent Inflation and Rising Rates

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Note: The following is an excerpt from this week’s Earnings Trends report. You can access the full report that contains detailed historical actual and estimates for the current and following periods, please click here>>>

Here are the key points:


  • Estimates for the last two quarters of this year and full-year 2023 are coming down, even though positive revisions to the Energy sector continue to partly offset estimate cuts elsewhere.


  • The +1.5% earnings growth expected for the S&P 500 index in 2022 Q3 is down from +7.2% at the start of the period. Excluding the Energy sector, Q3 earnings are expected to be down -5.0% at present, a significant decline from +2.1% at the beginning of July.


  • Q3 estimates have been cut for 13 of the 16 Zacks sectors since the quarter got underway, with the biggest declines at the Consumer Discretionary, Consumer Staples, Technology, Retail and Conglomerates sectors.


  • On the positive side, Q3 estimates have gone up the most for the Energy sector, but the revisions trend has been positive for the Auto and Utilities sectors as well.


The overall corporate profitability picture emerging from the Q2 earnings season, with nearly all the results in, showed stability and resilience in key earnings drivers like consumer and business spending.

While this stability and resilience run contrary to worries of an imminent economic slowdown or even a recession, there are nevertheless early signs of weakness in both consumer and business spending.

The market appreciated Walmart’s (WMT - Free Report) results, but the favorable market reaction likely had more to do with fears created by its earlier pre-announcement. The inventory overhang at Walmart, Target (TGT - Free Report) and other retailers was mostly due to shifting consumer preferences. But part of the problem could be attributed to weakness in lower-income households as a result of inflationary pressures.

It makes intuitive sense for this consumer segment to be feeling some squeeze, as we heard from companies in a variety of industries, including AT&T (T - Free Report) . Other households seem to be doing just fine, as we heard from banks, credit card operators and beyond.

With respect to business spending, we have started seeing a squeeze on advertising budgets and hiring plans, but Microsoft (MSFT - Free Report) and others didn’t see anything disconcerting with respect to spending on software and other services. That said, it is reasonable to expect some moderation in demand trends going forward as the full extent of the Fed’s tightening cycle permeates through the broader economy.

A slowdown has gotten underway, but there is nothing in the earnings data, management commentary or guidance that would suggest the U.S. economy heading into a major economic downturn.

That said, estimates have started coming down, with the overall revisions trend turning negative even after accounting for the persistent favorable revisions trend enjoyed by the Energy sector.

You can see this in the revisions trend to Q3 estimates in the chart below.

Zacks Investment Research
Image Source: Zacks Investment Research

If we look at the evolution of Q3 earnings growth expectations on an ex-Energy basis, the expected growth rate has dropped from +2.1% on July 6th to -5% today.

The chart below shows how the expected aggregate total earnings for full-year 2023 have evolved on an ex-Energy basis.

Zacks Investment Research
Image Source: Zacks Investment Research

As you can see above, aggregate S&P 500 earnings outside of the Energy sector have declined -5.9% since mid-April, with double-digit percentage declines in Retail (down -14.5%), Construction (-10.7%), and Tech (-10.6%). Estimates have also been coming down in the Consumer Discretionary, Industrial Products, Medical and Finance sectors.

The Overall Earnings Picture

Beyond Q2, the growth picture is expected to modestly improve, as you can see in the chart below that provides a big-picture view of earnings on a quarterly basis.

Zacks Investment Research
Image Source: Zacks Investment Research

The chart below shows the overall earnings picture on an annual basis, with the growth momentum expected to continue.

Zacks Investment Research
Image Source: Zacks Investment Research

Please note that a big part of this year’s growth is thanks to the strong momentum in the Energy sector whose earnings are on track to grow +137.6% this year. Excluding this extraordinary Energy sector contribution, earnings growth for the rest of the index would be up only +0.3%.

There is a rising degree of uncertainty about the outlook, reflecting a lack of macroeconomic visibility in a backdrop of Fed monetary policy tightening. The evolving earnings revisions trend will reflect this macro backdrop.

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