Earnings at the half point of the season: no sign yet of any collapse

Published Fri, Apr 28 20238:46 AM EDT

At the halfway point for earnings, bulls are delighted earnings are coming in stronger than expected and expectations for the second half of the year remain high. Bears say bulls are in denial about the coming, much-anticipated recession. With 260 companies in the S & P 500 reporting, 79% are beating expectations, according to Earnings Scout. The average surprise was 6.1% above the estimate, slightly above the typical beat of roughly 6% seen prior to Covid. In other words: the average company is doing better than expected. "The lower bar set heading into earnings season...has paved the way for a strong quarter thus far," Tajinder Dhillon at Refinitiv told me. Here's what's really got the bulls excited: estimates for the second half are remaining steady and are reflecting anticipation of record quarterly earnings in both Q3 and Q4. What happened to the recession? How is all this optimism possible? Doesn't Wall Street understand that there is a recession coming? In a recession, earnings typically drop 10%-20%. Earnings are dropping, just not by much. It looks likely that starting in the fourth quarter of 2022, the S & P may record three consecutive quarters of earnings decline. That is an earnings recession, but the declines — all in the low single digits — are not causing a lot of consternation. S & P 500 earnings (YOY) Q4 2022: $53.15 (-3.2%) Q1 2023: $51.70 (-2.4%) Q2 2023: $53.82 (-4.4%) However, these were coming off of record quarters in the prior year period, with huge earnings for tech stocks. Those tech companies saw a "re-rating" of their earnings multiple last year that is still showing up in the estimates. Now, on the heels of positive earnings reports, many tech stocks are seeing second quarter earnings estimates rising in the past few weeks, including Microsoft, Meta and Alphabet. The second half of 2023: Record earnings, really? Hard to believe, but not only are analysts not factoring in a recession, they are assuming record earnings. After dipping in Q1 and Q2, the second half of the year is expected to see a dramatic rebound: S & P 500 earnings: record second half expected (YOY) Q3: $56.50 (+ 2.1%) (record) Q4: $58.06 (+ 9.9% (record) Source: Refinitiv There are two reasons earnings estimates are not dropping for the second half: the economic outlook is uncertain but not dire, and the markets are waiting for the Fed to halt and reverse its rate-hike program. "There hasn't been enough of a reason for analysts to pre-emptively start cutting outlooks," Steve Sosnick, chief strategist at Interactive Brokers, told me. "Managements are not giving them solid rationales for guiding lower, and neither the companies nor the analysts seem inclined to bet on a potential recession when the economic outlook remains murky." Sosnick said this also works the other way: few companies are raising their full-year outlook, despite beating in the first quarter, a sign of uncertainty over the "soft landing" hypothesis. The second reason earnings are not dropping: the anticipation of Fed rate cuts by early 2024. "Analysts do not want to cut earnings in the second half because much of Wall Street believes the Fed will begin reversing its rate hike program late this year and into next year," Nick Raich from Earnings Scout told me. "If you think rate cuts are coming, why would you as an analyst lower your outlook?" The biggest gains in Q4 are expected to come from cyclicals like industrials (up 14%), and growth (technology + 12%), communication services (up 39%) and consumer discretionary (up 18%). That confidence in growth and many cyclicals is a sign of faith in the "soft landing." A soft landing? Many do not believe it The expectations that the soft landing will materialize in the fourth quarter and earnings will hit record highs seems like a bridge too far for many. "Earnings are creeping a bit higher, but it's going to be very hard for the S & P to reach the...consensus number people are looking for in Q4," Matt Maley from Miller Tabak told me. "Are we really going to see quarterly earnings increase by 14% between now and then? It's hard to imagine the economy will allow for that kind of growth given what we're hearing from companies like UPS, Taiwan Semiconductor, CAT, Old Dominion, and Samsung. People are still going out to dinner, but demand in other areas is beginning to decline."