Storm front on the horizon for US earnings season

There’s a week until the US second quarter earnings season starts with reporting from the usual suspects in the shape of the big six banks, an airline and a couple of other majors, but already there is considerable doubt about the size of any gain and the quality of the figures.

Why the doubt? Well, think of unsettled, indeed weak markets, rising inflation, higher oil prices, wages pressures, weak demand from consumers, supply chain problems and the ripples from the Russian invasion of Ukraine.

Exxon has already given us a glimpse of the boost coming for energy companies with a forecast for the quarter of a record $US16 billion – around double a year earlier.

An analysts nightmare all rolled into a quarter and beyond.

Financial services group, FactSet says More S&P 500 companies are issuing negative earnings guidance for the second quarter and for the full year compared to recent averages. But so far, the numbers are not at record-high or peak levels.

“In terms of quarterly EPS guidance, 103 S&P 500 companies have issued quarterly EPS guidance for the second quarter. Of these companies, 71 have issued negative EPS guidance and 32 have issued positive EPS guidance.

“The number of companies issuing negative EPS guidance is above the five-year average of 59 and above the 10-year average of 66. In fact, the second quarter has the highest number of S&P 500 companies issuing negative EPS guidance for a quarter since Q4 2019 (73)

FactSet also points out that the current forecast is for a 4% rise in second quarter earnings and “If 4.0% is the actual growth rate for the quarter, it will mark the lowest earnings growth rate reported by the index since Q4 2020 (3.8%).”

But analysts say if the results of energy majors like Exxon, Chevron, Occidental and other commodity-based companies are stripped out of the results, revenues and earnings will be lower this quarter compared with the three months to March but probably higher than a year ago.

Major banks led by JP Morgan, Goldman Sachs, Morgan Stanley, Bank of America, Citi and Wells Fargo are kick off what will be a mixed period (July 15-16) for the 500 companies in the S&P Index.

The major banks got a tick of approval from the US Federal Reserve in the most recent stress tests, but JPMorgan, Bank of America and Citgroup have had to lift their capital stress buffers by up to 1% to give themselves greater reserves.

That’s why JPMorgan and Citi held their dividends and while Bank of America lifted its payout by 5%, it, like JPMorgan and Citi didn’t announce any share buybacks. Morgan Stanley was the only one of the six big banks to revealed a buyback – a $US20 billion operation.

Second quarter underwriting and IPO income will be lower but trading income should be solid for the big banks.

Inflation and supply chain problems will again dominate quarterly reports – especially inflation which was the dominant factors mentioned in March quarter earnings calls and commentaries, according to FactSet.

Retail majors Target Corp and Walmart have already warned that oil prices are cutting into their bottom lines. They will not be alone in the June quarter reporting season.

More and more investors and fund managers wonder if analysts are on top of the impact of high energy prices on March quarter revenue and earnings estimates.

“On the surface, earnings remain strong, however surging energy prices may begin to cut into margins through 2022,” said Jason Pride, chief investment officer, Private Wealth, at Glenmede, a US wealth manager.

The S&P 500 is down 18% year-to-date, on track for its worst first half of any year since 1932, as inflation surges and the Fed tightens monetary policy and admits a recession could be a possibility.

US first quarter growth contracted 1.6% (annual) after a 6.9% jump last year). Growth everywhere else is slowing as well. The International Monetary Fund now says US GDP will be lucky to grow 1% in 2024 after a sluggish 2.7% burst this year.

“There’s no way to avoid it,” said John LaForge, head of real asset strategy at Wells Fargo Investment Institute. “ hen commodities do real well you almost always find stocks are stuck in a bear market because they’re squeezing their margins.”

The selloff in commodities in the past two weeks is a sign investors are fearful that a recession is taking shape in the US.

The high US dollar is clipping earnings especially for tech and other major exporters. Oracle, the big services and cloud company said the higher dollar cut its 4th quarter revenue by 5%.

But for retailer importers like Target and Walmart, the stronger greenback is also knocking the edges off some of those inflationary price rises for imported goods.

While second-quarter profit growth forecasts have fallen in recent weeks, estimates for the third and fourth quarters and for all of 2022 have held up or risen, according to IBES data from Refinitiv (according to Reuters).

Wall Street analysts expected S&P 500 2022 earnings to grow by 9.6%, up from 8.8% at the start of April and from 8.4% at the start of 2022.

FactSet said document search for key words or phrases across earnings reports for the term “inflation” in the conference call transcripts of all the S&P 500 companies that conducted earnings conference calls from March 15 through to mid June.

“Of these companies, 417 cited the term “inflation” during their earnings calls for the first quarter, which is well above the five-year average of 155. In fact, this is the highest number of S&P 500 companies citing “inflation” on earnings calls going back to at least 2010 (using current index constituents going back in time),”FactSet pointed out

“The previous record was 357, which occurred in the previous quarter (Q4 of 2021). In addition, the first quarter marked the highest percentage of S&P 500 companies citing “inflation” on quarterly earnings calls going back to at least 2010 at 86% (417 out of 487).

At the same time the March quarter season saw 102 S&P 500 companies which issued earnings per share guidance for three months to June and FactSet says 71 or 70% of those companies have released EPS estimates under market consensus.

That’s higher than the five year average for lower guidance of 60%.

March quarter earnings ended up 9.1% from the first quarter of 2021, better than the 5.8% consensus from analysts.

Revenue rose by an even-better 13.6%, up from preliminary forecasts for a 9.7% rise. The early influence of the energy giants and the Russian invasion of Ukraine and its boost to oil and gas prices, were the big influences here.

Analysts say the FactSet data suggests that the first quarter was a solid one for corporates, but somewhere in March, demand suddenly slowed for a lot of companies (but not energy groups) and that in turn saw revenue growth slow and margins come under pressure.

Goldman Sachs economists cut their second quarter GDP forecast this week to a rise of just 0.7% (annual) from 1.9%

This has been put down to the sudden surge in inflation in March (The headline CPI rose 1.2% in March from February and 1% in May). The shock from higher prices, especially for energy, was topped up by the continuing supply chain problems that hit big retailers like Walmart and Target.

The double whammy of inflation and provide chain challenges have taken their toll on shoppers, notably on lower-income shoppers, and margins.

Retail sales growth fell 0.3% in May – a surprise after the gains of 0.9% in April, 1.4% in March and 2.7% in January (which was after the Omicron hit fall of 1.6% in December).

Warren Buffett and his Berkshire Hathaway group know the attraction of energy investment. They continue to buy shares in Occidental Petroleum.

Berkshire now has more than 16% of the issued shares and over 25% if you take into account 83.9 million convertibles also held by Buffett’s company. Berkshire bought another 12 million Occidental in the past week.

Analysts say that is you strip out the revenue and profits of the energy companies in the about to start reporting season, both measures will be negative for the rest of the reporting companies – a truer picture of the state of American corporate finances than with the energy groups in the comparison.