How earnings season is likely to play out in the coming weeks and its impact on the stock market

Published Mon, Jul 12 20213:08 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

The great cyclical rebound is about to get underway with outsized gains expected in the quarterly profits of industrial, consumer discretionary, energy and materials companies. Earnings growth in the second quarter is expected to be a stunning 66%, as companies compare their results to the depressed period last year when the pandemic abruptly shut down the economy, according to Refinitiv data. Normally a profit leader, the technology sector this quarter, is expected to see just 32% profit growth, according to Refiniv. That compares to shockingly large estimated increases in industrial sector profits of more than 570%, and energy industry profits, up 220%. Earnings for the financial and materials sectors are expected to be up more than 100% each. Those huge gains and expected earnings beats should be a positive for some cyclical stocks this quarter. Earnings season kicks off Tuesday with reports from JPMorgan Chase, Goldman Sachs, and PepsiCo . This earnings season will be the period where the tug of war that's been a factor in the stock market, between cyclical and growth trades, is due to play out very clearly in the earnings numbers. Inflationary pressures, negative for tech stock performance, are expected to help boost cyclical earnings growth in the rebound, as companies face rising input costs but also up their prices. "I think what you're going to see is a very unusual kind of contradiction between the data and the narrative," said Jonathan Golub, chief U.S. equity strategist at Credit Suisse. "What companies are going to say is they are facing shortages and rising input costs and other things which are constraints to their success. And then what you're going to see is massive beats and the biggest portions coming from higher margins. They're not going to try to reconcile it." Golub expects companies to provide detail on rising costs and supply shortages but not as much information on how much they are raising prices or how broadly. "If you listen to what the CFOs are going to say, you're going to think the earnings are terrible, but if you look at the results, they're going to be magnificent," he said. But ultimately, it's tech and growth that will prove to be the best performers profit-wise over the long haul. "Their own earnings revisions for themselves are still good. They're not deteriorating. They're solid. They're not getting worse. They're not accelerating in this ridiculous way. They're on the same solid trajectory they've been on," said Brian Rauscher, Fundstrat head of global portfolio strategy. Rauscher expects the trend to revert back to tech as the better earnings performer in two quarters from now, when cyclical airline stocks or industrial stocks like Caterpillar will see earnings growth back in the single digits. "Tech will keep growing at 25%," he said. He says economic growth will have slowed to a more normalized and sustained pace. By then it will be more apparent whether inflation is temporary or not. "If they are unable to pass along price increases, it will hit the earnings," he said. Golub points out that tech profits in last year's second quarter actually increased by 3.3% from 2019, as cyclical earnings plunged 85% in the same period. The 2021 second quarter earnings growth estimate for tech is 34.2%, while some cyclical earnings will rebound by more than 570% just to get back to even with 2019. "It says one of these is a near term trade, and one of them is a long term trade," said Golub. "Once the supply chain issues are gone, [cyclicals] are going to be unimpressive." Even with the push pull of tech and growth versus cyclical trades, strategists say the earning season should be good for the stock market. "I think the numbers will be very good, and it'll be supportive for markets," said Rauscher. He said some investors may be concerned that a peak period of earnings this quarter will lead to a market decline but he doesn't expect that to be the case. "Obviously, the numbers are going to be outsized because we have that weird comparison from last year. I think the important thing is going to be the return of guidance," Rauscher said. Both he and Golub say they expect earnings to beat to the upside. "I think the analysts have underestimated the improvement in operating leverage," Rauscher said.

A person works on a Polaris snowmobile assembly line at their manufacturing and assembly plant in Roseau, Minnesota, June 7, 2021.

Dan Koeck | Reuters

The great cyclical rebound is about to get underway with outsized gains expected in the quarterly profits of industrial, consumer discretionary, energy and materials companies.