Ah, the unmistakable signs of Fall are here – the crisp chill in the air, pumpkin spice adding autumnal warmth to seemingly every store shelf, and the lush green foliage gracefully yielding to a kaleidoscope ablaze with vivid colors. Yes, Fall is upon us which of course means third quarter earnings are approaching. Much like the changing of the leaves, we’re looking to see how companies are navigating the changing macro environment. These updates from companies will help ground investors who are trying to digest rapidly evolving data points. Last quarter, CEOs were clamoring to illuminate their efforts in AI. This quarter the focus will be on the outlook for the rest of the year and into 2024, especially as businesses are digesting higher interest rates and softening demand. The good news is that as business conditions continue to normalize, supply chain and labor headwinds are abating, and profitability is expected to improve next year. Analysts expect this will lead to double digit earnings growth for the S&P 500 in 2024 and investors are looking for data points to build conviction in this outlook.
Expectations are that third quarter earnings will be flat year over year, a welcome reprieve from the declines witnessed over the past two quarters. This stability, while appearing ‘flat,’ is a hopeful sign that earnings are at a turning point that will support equities’ growth in 2024. Markets, always forward-looking, have rallied year to date on optimism that this growth will return in late 2023 and into 2024. A better-than-feared outlook could give this market the fuel it needs to finish the year on a high note, whereas a more cautious tone might suggest that investors need to lower expectations for the year ahead.
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Here are a few key sectors we’re watching…
Financials: Big banks, led by JP Morgan and Wells Fargo will kick off the season when they report later this week. The regional banking failures from earlier this year seem in the distant past. The liquidity crunch that spurred the crisis sparked competition for deposits and forced many banks to rely on higher-cost sources of funding. These pressures along with further rate hikes from the Fed will likely drag net interest margins lower. Banks are preserving liquidity and slowing loan growth in order to rebuild reserves. Despite this near-term caution, once banks have sufficiently shored up their balance sheets, higher rates should provide a boost to profitability assuming continued economic growth.
Consumer Discretionary: We carefully scrutinize reports from the consumer discretionary sector to glean valuable insights about the health of the consumer. In the second quarter, a trend emerged where consumers were ‘trading down,’ a shift highlighted by Walmart’s CEO who noticed an increase in high-end vehicles in their parking lots. We expect to see an increasingly promotional market environment meant to boost consumer activity into the holiday season. However, these discounts might come at the expense of corporate margins and, consequently, earnings growth. Despite relatively weak performance recently, it’s worth noting that the current environment appears much more favorable than 2022. Last year was marked by supply chain disruptions and wage inflation that served as a material drag on profits. Analysts have adjusted their estimates upward for this sector, though it seems like the bar is still low. We would like to see these companies exceed expectations, which would bode well for the consumer and the economy.
Energy: We’ve also got our eyes on the Energy Sector. Given the sector’s recent double-digit rally from summer lows, it might seem logical to assume that earnings are surging. However, the reality is energy earnings have fallen this year, largely because of declining oil prices. Oil prices were over $100 a barrel in 2022 but retreated below $80 a barrel for much of the year. Remember equities are forward looking. The recent surge in oil prices suggests a potential return to robust growth in 2024 for these companies, which is why we’re overweight the energy sector.
As businesses and consumers acclimate to the new reality of higher for longer interest rates, the forthcoming insights offer crucial perspective. Third quarter earnings will provide data points for investors to base forward-looking assumptions on. If analysts maintain, or increase, earnings expectations for 2024, then a Christmas rally could grace the market, infusing the season with optimism. Key focal points, such as the stability of bank balance sheets and consumer spending patterns, will serve as a barometer of economic health. Given the pessimism heading into this earnings season, we hope investors will be pleasantly surprised by the updates.
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