Wall Street expectations are high for the second-quarter earnings season. The market has already surged to new highs ahead of the corporate earnings season that begins this week with Goldman Sachs (GS, Financial), JPMorgan Chase & Co. (JPM, Financial), Citigroup Inc. (C, Financial) and Bank of America Corporation (BAC, Financial) leading the way.
Investors are waiting to see if companies can beat Wall Street earnings expectations once more, and with stock prices above long-term averages, they are also looking for clues about company profitability in the future. The S&P 500 Index has risen 16% this year and is trading at about 22 times its forecasted earnings over the next 12 months, which is above the five-year average of 18. According to FactSet, profits for S&P 500 companies are expected to be up by 64% in the second quarter from a year earlier. The financial services and industrial sectors, which were restrained by the pandemic in the last year, are expected to drive earnings growth.
Commenting on second-quarter earnings expectations, senior investment strategist at Ally Invest Callie Bost said:
“The second quarter could be as good as it gets for economic growth. Earnings growth may slow, but analysts still expect S&P profits to grow by double digits in the next two quarters. It’s crucial not to lose faith in the market just because the economy’s strongest growth may be behind us.”
Investors are looking to use corporate earnings this quarter as an indicator to predict which industries and companies are gearing up to deliver stellar returns in the coming years.
These sectors might be the big winners
Analysts believe that the banking sector has benefited from the economic recovery and is likely to report strong results this quarter. Major banks are also planning to boost their dividend payouts as they have been given the green light by the Federal Reserve following the stress test results released in June. The Fed confirmed that the capital level of the industry is well above the minimum threshold required during a severe economic downturn.
Commenting on the expected performance from the banking sector in this earnings season, managing director of Vios Advisors at Rockefeller Capital, Michael Bapis, said in an interview:
“Many of the key components and fundamentals are lining up in the bank’s favor. They passed all the stress tests, their most recent stress tests, and they’re trading anywhere between 11 and 15 times earnings, which is historically low for the banking stocks. I believe you own them and you keep them for the long term and I would almost overweight banks right now in financials.”
According to FactSet, the financials sector is expected to have the third highest earnings growth rate among all the sectors. Going by these projections, it would be reasonable to expect bank stocks to gather some momentum in the next couple of weeks as earnings are reported.
Other sectors that are expected to see the highest earnings growth include industrials, consumer discretionary and the materials sector. The energy sector is also expected to deliver a strong performance given that crude oil prices have trended upwards throughout the second quarter.
Investors might want to avoid these sectors
Sectors that outperformed during the global pandemic and in the first quarter of 2021 are expected to report a decline in earnings growth rates starting from the second quarter. According to FactSet, the consumer staples, health care, technology and utilities sectors will report negligible growth in earnings per share for the second quarter. Many companies in these industries were able to post positive earnings for the most part during the health crisis, but the stellar recovery that followed has made it difficult for these companies to carry the momentum any longer. Zoom Video Communications, Inc (ZM, Financial) and Netflix, Inc. (NFLX, Financial) are classic examples of companies that might report lackluster earnings growth in this quarter. Opportunistic investors could look for bargains in these sectors if the share price of a high-growth company irrationally declines following the release of earnings.
Exhibit 1: Earnings growth expectations for Q2 by sector
Source: FactSet
The overall earnings picture is promising
More than 64% of the companies that have announced earnings guidance for the quarter have guided for strong year-over-year growth in profits. This is a very promising trend as it underpins the strength of the economic recovery that is taking place in the United States today. For the best part of the last 18 months, the financial services sector and the energy sector failed to gather momentum and underperformed all other sectors in the market because of the uncertainty surrounding the corporate earnings of these two business sectors. Things are finally set to change in this earnings season, which is expected to be another positive development for the performance of the broad market.
Wall Street analysts expect the S&P 500 to gain over 11% in the next 12 months based on the percentage change between the bottom-up target price and the index's closing price.
Exhibit 2: The expected return of the S&P 500 Index and its sectors in the next 12 months
Source: FactSet
If earnings come in better than expectations, Wall Street analysts are likely to revise their estimates for third-quarter earnings, which could turn out to be a driver of stock prices as well.
Takeaway
Consumer purchasing activity has risen because of the economic recovery fueled by favorable monetary and fiscal policy decisions. Higher inflation is also the friend of bullish sentiment, as it makes company earnings look artificially higher and can even disguise lackluster results.
Second-quarter earnings will reveal how businesses are progressing more than a year after the health crisis pushed the U.S. into recession. Many companies will discuss their expectations for inflation as well, which is something that investors are looking forward to as the remarks of corporate executives could reveal whether the Fed will be forced to hike interest rates soon because of the rising inflation. There will be both winners and losers in this earnings season, but I think the overall impact of earnings on stock prices should be positive considering the low bar set in the second quarter of 2020.
