S&P 500 would be in an ‘earnings recession’ if not for this one booming sector — but that may not last long

Fears of an actual recession weigh on investors towards the end of 2022, but there’s another kind of recession on the horizon too: an earnings recession.

The S&P 500 Index would already be in an earnings recession were it not for one high-flying sector in 2022: energy. Higher oil prices have translated into huge gains for energy companies so far this year. FactSet is forecasting a 118% increase in third-quarter earnings once earnings start rolling in, in line with the huge gains seen in the first half of the year.

Overall, FactSet is forecasting earnings per share growth of 2.4% for the entire S&P 500 in the third quarter compared to the same period last year. Delta Air Lines Inc. DAL,
and big banks like JPMorgan Chase & Co. JPM,
Earnings season for the quarter begins next week as Wall Street focuses on whether companies can pivot amid higher prices, a stronger dollar, lopsided supplies and signs of weakening demand.

Excluding the energy sector, the earnings estimate for the third quarter would fall to a 4% decline. In the second quarter, earnings were down 4% excluding gains in energy.

Put the two quarters together and you have a non-energy earnings recession or at least two quarters of bottom line declines. If you include the energy sector but exclude every other individual sector, overall S&P 500 earnings growth rates would remain positive for both quarters, said John Butters, senior earnings analyst at FactSet.

But even as the weather cools, Russia’s war in Ukraine drags on, and OPEC and its allies plan to cut production, the energy sector’s contributions to earnings growth are likely to fade soon as it faces tougher year-on-year comparisons.

“Q4 is the last quarter where energy is expected to really be a key driver of earnings growth,” Butters said in an interview. “Going forward, really after Q1 2023, this is expected to weigh on earnings rather than be a positive contributor.”

The S&P 500 Index SPX,
suffered from an earnings recession throughout 2019 after many companies’ profits soared in 2018 on federal tax cuts. With earnings still rising above the record rates of 2021, projections seem to suggest another earnings recession is on the horizon in 2023.

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The all-inclusive estimate of 2.4% earnings growth would be the worst result since the third quarter of 2020, when much of the economy was still gripped by pandemic lockdowns. These estimates have also fallen significantly since the summer. Three months ago, estimates for the third quarter called for 9.8% year-over-year growth, Butters said. The gap between these estimates is larger than average, and some strategists believe they haven’t come down enough.

Still, Butters noted that historically, more than 70% of S&P 500 companies have beaten earnings estimates each quarter, although the magnitude of those overruns this year has been below average. But he said if recent trends are confirmed, actual earnings growth for the third quarter could reach about 6%.

In terms of revenue, the third quarter is expected to grow 8.5% for the S&P 500 companies compared to the third quarter of 2021. Margins should come in at 12.2%, still staying close to the high levels seen earlier this year, but slightly off some of the records set last year. However, both numbers have been supported by higher prices, although higher wages are eating into margins.

Other analysts, meanwhile, have wondered if the latest results from sports equipment giant Nike Inc. NKE,
and chipmaker Micron Technology Inc. MU,
– each hampered by aggressive discount plans to de-stock and an abrupt collapse in demand – offered foreshadowing of the results to come. And as recession worries mount, they’re wondering if companies have exhausted all the profits they can squeeze out of customers by charging more.

“The question now is, ‘Is pricing power out of the system?'” said Nancy Tengler, chief executive at Laffer Tengler Investments. “Will companies be able to raise prices further?”

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This week in the result

For the coming week, 15 S&P 500 companies, including three from the Dow Jones Industrial Average, will report quarterly results, according to a report by FactSet on Friday.

Along with Delta and JPMorgan Chase, one of those components of Dow, two others – health insurer UnitedHealth Group Inc. UNH,
and Walgreens Boots Alliance Inc. WBA,
– also report. PepsiCo. Inc. PEP,
also report during the week.

The call to mark your calendar: JPMorgan Chase

JPMorgan Chase will report third-quarter earnings on October 14, followed by the conference call. The bank is considered by many to be an economic leader. But with the economy on the move, investors will likely turn to CEO Jamie Dimon for updates on consumer spending and demand for credit as prices and borrowing costs rise, markets slump and central banks around the world seek to contain inflation to fight.

Dimon, in a recent survey on Capitol Hill with other bank executives, pointed out that given the current backdrop, banks have shown some resilience.

During a conference last month, JPMorgan chief operating officer Daniel Pinto pointed to the possibility of “a couple of quarters of shallow recession” if the Federal Reserve’s interest rate curve isn’t enough to fight inflation. But for now, spending and the labor market have remained “resilient,” despite inflation, the war in Ukraine and other geopolitical tensions, and the Fed’s efforts to take the guard rails off the economy after a massive infusion of pandemic-related aid. And he noted easing, albeit still elevated, energy prices and less pressure on the supply chain — two key reasons for higher prices over the past year.

“So basically it’s okay overall,” he said.

Keeping track of the number: bank profits, forecasts

Analysts polled by FactSet expect JPMorgan to earn $2.92 per share for the quarter, down from the same quarter last year. But sales would soar to $32.1 billion during that time.

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But even as banks try to move through slowing trends in investment banking and weaker demand for auto and home finance in the face of higher interest rates, Wall Street analysts’ earnings prospects have largely held up.

Even if higher Fed rates make borrowing more expensive for consumers, those rates allow banks to charge more for things like credit cards and car loans, increasing their net interest margins.

“People don’t understand that there’s still demand for credit,” Dave Wagner, portfolio manager and analyst at Aptus Capital Advisors, told MarketWatch in a separate earnings preview from the bank. “Banks can still benefit from higher average yields and excess liquidity.”

Citi analyst Keith Horowitz said on Tuesday that JPMorgan had been “more disciplined than others about using cash” and expected the bank to raise its net interest income outlook, or profit on lending, at a higher rate than what a bank paid to depositors. He said bank stocks overall have remained “oversold on credit concerns.”

Elsewhere, Citigroup Inc. C,
also reports on Friday, with the results potentially offering clues as to the state of the international financial sector. Wells Fargo & Co WFC,
and Morgan Stanley MS,
also report that day.

Delta earnings are also due

Delta Air Lines reports third-quarter results on Thursday. Analysts polled by FactSet expect the airline to earn $1.55 per share on revenue of $12.9 billion. The results will offer some insight into whether the travel industry’s recovery still has momentum as prices rise.

William Walsh, director general of the International Air Transport Association, told CNBC last month that airfares could rise. However, Delta President Glen Hauenstein remained bullish on travel demand during a conference last month.

“We’re expecting very, very robust demand for the holiday season, both Thanksgiving and Christmas,” he said. “And for us now it looks like business is going to take a really big hit which is always great for October.”

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