Earnings at the half: reports of their death are greatly exaggerated, so far

Published Fri, Jul 29 20229:00 AM EDT

Dire warnings in June that earnings were about to collapse due to an imminent, and severe, recession have not materialized. Estimates for the second half of the year, while slightly lower than a month ago, are still showing healthy gains, now expected to expand 8.8% for all of 2022, according to Refinitiv. S & P 500 2022 earnings: No recession in earnings Q2: +7.6% Q3: +9.0% Q4: +8.6% 2022: +8.8% 2023: +8.3% Source: Refinitiv Earnings are reflecting a slowdown, but not a recession Recessions almost always produce a decline in earnings. In mild recessions, earnings typically decline 10% to 20%. In more severe recessions, they can slide by 30% or more. Yet here we are, midway through earnings season, and estimates for the second half of the year and for 2023, while down slightly, are still positive for the year. That's a good sign for the corporate outlook for the second half of the year, JP Morgan's Dubravko Lakos-Bujas said in a note to clients on Thursday. "For investors looking for confirmation of a slowdown without recession, the lack of significant earnings revisions lower would be a key signal for inflection," he said. "We are not anticipating negative y/y EPS growth outside of a deep U.S. recession." Earnings have been lowered in several key sectors You have to be careful looking at overall earnings numbers this year. That's because several of the largest companies have seen very significant earnings reductions — declines that are so large on a dollar basis that they move both the sector and overall S & P profit expectations. These include Amazon, Starbucks, Netflix, and Meta. Take the Consumer Discretionary sector. A large part of the decline is due to two companies, Amazon and Starbucks. Amazon alone is expected to see an earnings decline of 90% this year (it has posted losses for two straight quarters). Other retailers (Home Depot, Lowe's) are expected to see their earnings increase, as are most home builders, including Lennar and Pulte. Consumer Discretionary earnings 2022 April 1: +6.9% Today: +0.7% Source: Refinitiv Communication Services are also seeing a decline in earnings expectations, led by Netflix and Meta (Facebook). Meta alone is expected to see total earnings decline 25% this year. However, other stocks in the sector, such as Walt Disney, are seeing earnings estimates move higher. Communication Services estimates 2022 April 1: +1.9% Today: -8.8% Source: Refinitiv Technology, by contrast, has seen only a modest decline in earnings expectations and will likely be bolstered by Apple's earnings: Technology earnings estimates 2022 April 1: +9.2% Today: +7.0% Source: Refinitiv Oil companies, by contrast, are just gushing profits, which are going up on a monthly basis. Energy 2022 profit expectations: sky's the limit January 1: +28% April 1: +65% July 1: +122% Today: +138% Source: Refinitiv There is an unusually wide dispersion of profit winners and losers this year Outsized declines in the profits of some of the largest companies (Amazon, Starbucks, Netflix, and Meta) are putting downward pressure on their respective sectors and the wider S & P 500 profit picture. Conversely, the enormous profit increases of the biggest oil companies are so large on a dollar basis they are pulling up the estimates for all of the S & P 500, even though many are fairly small on a market cap basis. The bottom line: it's a really weird year for profits. In place of an imminent crash, we now have the August-September swoon expected As expectations have shifted toward a "mild" recession, even bulls are hedging by admitting that light volumes and a few worse-than-expected economic reports can produce another leg down in the markets, particularly as the public digests the implication of an economic slowdown. Typical is Julian Emanuel at Evercore ISI: "The psychology of inflation in a weakening economy with declining earnings forecasts amid the start of layoff announcements...is likely to give the Investing public pause as future employment prospects become more of a consideration," he said in a note to clients Thursday. All of this makes investors — and their advisors — cautious, especially since it seems to most professionals that earnings should be lower. "Earnings resilience is not a surprise," Alicja Plonska, senior vice president at Morgan Stanley Wealth Management, told me. "Do we expect a downshift? We think it's very likely, and we worry that the 8% expectations for next year seems optimistic."