Markets Brief: What to Watch for in Q3 Earnings

Companies have only just started reporting third-quarter results, but investors are bracing for the worst. Punk earnings could spell further downside for an already battered stock market.

“We expect earnings to be weak,” said Phil Orlando, chief equity market strategist at Federated Hermes. “The trends we saw earlier in the year have continued in the third and fourth quarters and that will result in slowing growth and a rapid deterioration in profit margins.”

One exception: Energy companies are likely to keep going and continue to post stronger-than-expected earnings as demand for oil and natural gas is strong and prices remain elevated. It was the only sector to see significant upward revisions to earnings during the quarter. Another bright spot: earnings should remain positive across the board and benefit from higher inflation.

“The swing factor is guidance,” Orlando says, referring to the practice of executives making estimates for the coming quarter and year and setting expectations for their companies. “I think it will be very careful. The guidance for the fourth quarter and full year 2023 is in question.”

What to Look for in Third Quarter Results

  • Economic Forecasts: Investors will be watching for cues from corporate leaders on whether inflationary headwinds are easing or strengthening and whether they are bracing for a recession.
  • Consumer demand: With consumer spending crucial to sustaining economic growth, investors will be paying close attention to credit, new orders, inventories and sales.
  • Occupation: Businesses have been struggling with a tight job market and staff shortages throughout the pandemic. However, if demand slacks, watch for more layoff announcements as companies look to cut costs.
  • Profit margins: How well do companies cope with higher costs as demand changes?
  • Supply Chains: Blockages along the supply chains in the movement of goods and materials were a huge disruptive force, resulting in lost sales and higher costs. Any improvement on this front would be a relief for investors.
  • currency impact: The strong US dollar has hurt profits for large multinational and technology companies with extensive overseas presences. Investors will try to estimate how long the strong dollar is likely to be a factor.
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Savita Subramanian, Bank of America’s equity and quantitative strategist, in a third-quarter preview titled “Buckle Up!” says she expects earnings to slightly miss estimates but sees a big one starting in the fourth quarter downside risk. “The leadership will be terrible,” she says. She will watch for mentions of recession, weak demand and layoffs.

“Prices are peaking, demand is falling, but costs remain tough,” says Subramanian. “Our Corporate Misery Indicator continued to decline in Q3, suggesting worsening misery and increasing pressure on margins. Demand is key, which was the main driver of post-COVID pricing power. Weakening demand points to weaker pressure on prices and margins. Bloated inventories also pose a downside risk to margins, particularly for many retailers.”

In a recent article titled “The End of Earnings Growth,” Jeff Kleintop, chief global investment strategist at Charles Schwab, says stock valuations will come under further pressure as third-quarter earnings are likely to come in below expectations. Although Wall Street analysts have steadily lowered their estimates to reflect a slower growth environment, expectations are still too high, he says.

Kleintop points to the historically close correlation between manufacturers’ global Purchasing Managers’ Index (PMI) and corporate earnings growth. Trends in the PMI tend to be a forward indicator of future earnings.

“Leading components of the PMI, such as new orders, point to further economic slowdown in the coming months and an imminent earnings slump,” Kleintop wrote in his report. “If that’s the case, the erosion of earnings as a key support for equities could lead to another sell-off in equity markets in the coming weeks as corporate leaders tell analysts to lower their earnings estimates further.”

Corporate earnings held up well in the first half despite headwinds from inflation and supply chain disruptions. Now a doubly problematic combination of slowing economic growth and declining profit margins is beginning to hurt.

Higher labor, transportation and shipping, warehousing, fuel and energy costs are eroding companies’ profits and margins. Frugal consumers are retreating and trading down, pressured by sky-high prices for rent, groceries, medical care, new vehicles and public transportation, including airfares.

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In fact, the latest inflation data for September, released last week, showed prices rising 8.2% yoy, more-than-expected. The so-called core consumer price index, which excludes food and energy costs, rose to a new high of 6.6%.

Persistently high inflation will keep the pressure on the Federal Reserve to raise interest rates further as it attempts to rein in the fastest consumer price growth in 40 years.

According to Federated Hermes’ Orlando, technology and consumer discretionary companies will be the most challenged in this environment. Because consumer spending is such a key driver of US economic growth — accounting for about 70% of gross domestic product — the holiday season needs to be watched closely. He’s concerned that margins could be under extreme pressure. A cautionary tale: Walmart (WMT) plans to hire far fewer seasonal workers during the holiday season than it did last year. It will also offer additional hours to current employees before increasing staff.

Subject to company guidance and based on a forecast of negative economic growth for the first quarter, second quarter and full year of 2023, Federated Hermes is considering lowering its 2023 earnings estimate for the S&P 500 to $200 from $230. In comparison, the current Wall Street consensus is $238.

Bank of America’s Subramanian also forecasts a $200 gain on the S&P in 2023.

“We’re on a glide path to a full-blown recession next year,” Orlando says. “Judged, that’s what we think.”

The following events are planned for the coming week:

  • Monday: Bank of America (BAC) and Bank of New York Mellon (BK) report earnings.
  • Tuesday: Netflix (NFLX), Johnson & Johnson (JNJ) and Goldman Sachs (GS) report gains.
  • Wednesday: Tesla (TSLA), United Airlines (UAL) and Procter & Gamble (PG) report results.
  • Thursday: American Airlines (AAL), AT&T (T) and Snap (SNAP) report earnings.
  • Friday: Huntington Bancshares (HBAN), Verizon (VZ) and American Express (AXP) report gains.

For the trading week ending October 14:

  • The Morningstar US Market Index fell 1.78%.
  • The best performing sector was the defensive consumer sector, up 1.07%.
  • The worst performing sectors were Technology, down 4.37%, and Consumer Discretionary, down 3.65%.
  • returns on the US10-year government bonds rose to 4.01% from 3.88%.
  • West Texas Intermediate crude prices fell 7.59% to $85.61 a barrel.
  • Of the 843 US-listed companies covered by Morningstar, 282, or 33%, were up and 561, or 67%, were down.

Which stocks are up?

Albertsons (ACI) shares rose after Kroger (KR) agreed to buy the supermarket operator in a $24.6 billion deal, CNBC reported. Kroger’s shares rose by an inch.

“While we believe a combination between the two largest pure-play grocery retailers in the United States would create economies of scale (and associated cost and shopping advantages) that would help fend off burgeoning omnichannel titans Walmart and Amazon, we suspect overlaps between the two chains. Footprints in many markets can prompt regulators to scrutinize a transaction,” said Zain Akbari, equities analyst at Morningstar.

Walgreens Boots Alliance () the stock rallied after the pharmacy retailer released results that beat market expectations. Management now expects fiscal 2023 earnings per share to be in the range of $4.45 to $4.65.

“This guidance is based on the rapid acceleration of the U.S. healthcare business and core business growth, offsetting adverse currency movements and headwinds in COVID-19 vaccine volumes,” said Julie Utterback, senior equity analyst at Morningstar.

Shares of Moderna (MRNA) and Merck (MRK) rose on news that the two drugmakers would combine to create personalized cancer vaccines for patients with high-risk melanoma, CNBC reported.

Line chart showing the performance of ACI, KR, WBA, MRNA, MRK in the week of 10/14/2022.

Which stocks are down?

Five9 (FIVN) shares plummeted after CEO Rowan Trollope announced he was leaving the software company, CNBC reported.

Volatility in solar stocks continued, with the likes of SunPower (SPWR) and Sunrun (RUN) ending the week lower after a hotter-than-expected CPI report was taken as further evidenceThe Federal Reserve would continue to raise interest rates aggressively, worrying the high-growth industry.

Tech stocks also fell over the week on rising concerns about a potential recession, with Zscaler (ZS), RingCentral (RNG) and Atlassian (TEAM) among the worst performers.

Line chart showing the performance of FIVN, SPWR, RUN, ZS, RNG in the week of 10/14/2022.


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