It’s still early in earnings season, but the results so far are coming in strong enough that some on Wall Street are starting to wonder if they were too pessimistic about Corporate America’s performance.
Roughly 20% of the S&P 500 Index has posted quarterly earnings and more than 77% of the reports were better than expected, according to data from Bloomberg Intelligence. Solid results from the country’s megabanks, and better-than-feared outcomes from smaller lenders are driving the strong start to the first-quarter earnings season.
“We’ve seen a large number of the names that have reported so far beat expectations, so that’s encouraging,” said Mike Loewengart, head of model portfolio construction for Morgan Stanley’s global investment office. “It begs the question: Were expectations intentionally set too low, and are they still too low?”
The overall strength in results so far had Bank of America strategists led by Savita Subramanian pondering whether their 2023 EPS target of $200 for the S&P 500 was too grim, according to a note to clients this week. The consensus earnings forecast for S&P companies over the next 12 months is $219 a share, data compiled by Bloomberg show.
Part of the reason for strategists mispricing earnings could be that the highly anticipated earnings recession actually has been happening under the surface for nearly a year — and may be nearing an end.
An earnings recession is typically defined as two consecutive quarters of corporate profits below their year-earlier level. And excluding energy, which skewed estimates for the broader index last year due to higher commodity prices and elevated inflation, S&P 500 earnings have been declining year-over-year since the second quarter of 2022, according to Bloomberg Intelligence.
“Investors are forward looking, and a lot of this ‘earnings recession’ story has already been priced in, so forward guidance is far more important,” said Ken Xuan, Fundstrat Global Advisors’ head of data science research, pointing to the 15% climb in the S&P 500 since October’s low.
Still, some signs of cracks in the economy have started to emerge, and guidance will be key from here. For example, trucking giant J.B. Hunt Transport Services Inc. warned of a “freight recession,” a sign that an economic downturn may become more apparent in results from outside the financial sector.
“Concerns about continued deposit flights out of the banks have been greatly alleviated,”said Brad Conger, deputy chief investment officer at Hirtle Callaghan & Co. “I’m more interested in companies that have reference value for the state of Corporate American spending.”
That said, there are reasons to be hopeful, as broad profit growth is forecast to return in the second half of the year thanks in part to what could be the end of margin pain.
Operating margins are a key gauge of profitability that has a strong track record of signaling where US stock prices are headed. They were squeezed during the pandemic due to inventory overhangs, supply-chain snarls and escalating costs.
But operating margins appear to have troughed in the first quarter, as the annual rate of increase in prices paid by goods producers dropped below that for consumers by the most since 2009 in March. This is a sign that the low in S&P 500 operating margin estimates is already behind us, according to Bloomberg Intelligence.
Most importantly for the market and world at large, the worst of the stresses plaguing the banking industry appear to have passed. Major money center lenders reported healthy results last quarter, with JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co. and Bank of America Corp. thriving in a rising rate environment.
Meanwhile, regional lenders like Truist Financial Corp. and Fifth Third Bancorp reported that deposits largely held stable through March turbulence. And Western Alliance Bancorp said its deposits recovered after the collapse of three peers last month.
The financial sector has been a “stronger leading indicator this quarter,” BI senior analyst Wendy Soong said.
Other embattled regional banks report next week, including First Republic Bank on Monday and PacWest Bancorp on Tuesday.
Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.
In recent months, Wall Street has been consumed with anxiety as poor economic indicators and pandemic-induced disruption resulted in plummeting stock prices and weak performance from many of the nation’s largest companies. However, a string of better-than-expected earnings reports from some of the most prominent companies in the financial world has forced Wall Street to ask whether it has been overly pessimistic in its assessment of the country’s economic outlook.
After a significant decline in nearly all major indices since the start of the year, many investors have been concerned with the prospect of long-term economic decline and muted corporate performance. While some of these concerns have been borne out in the performance of large companies, others have not.
In particular, several major banks, including JPMorgan Chase, Wells Fargo, and Citigroup, released earnings reports that were far better than expected, thanks in part to strong trading activity. Similarly, tech giants like Apple and Microsoft posted strong results, overall limiting any potential damage that the coronavirus could have inflicted on these companies’ bottom lines.
This news, combined with other positive economic developments like a rebound in consumer spending and a strengthening job market, has observers questioning whether Wall Street has been too pessimistic. While the specter of prolonged economic hardship and further flux in corporate performance still looms large, the recent consistent string of good news could potentially mark the start of a shift in investor sentiment.
On the heels of this surprising development, many have called for investment in equities, as analysts have taken note of the potential for a longer-term recovery. As Wall Street wonders if it has been too pessimistic, investors appear to be taking a more optimistic view on the future of the American economy and its effects on the stock market.