Corporate Earnings Season Begins with Low Expectations from Wall Street

This week, the stock market will be put to the test as corporate earnings season begins. Many are concerned about how inflation and the economy's health will affect earnings.

Analysts expect that companies in the S&P 500 will report their first year-over-year decline in quarterly earnings since the height of the Covid-19 pandemic in 2020, according to FactSet. Fourth-quarter profits are projected to have dropped by 4.1%, which is a sharp reversal from the more than 31% growth that was logged a year earlier.

Companies have been facing a number of challenges, including high costs, rising interest rates and a sharp increase in the value of the dollar. While analysts have been reducing their earnings forecasts, investors are hoping that the next round of reports will give them some insight into how resilient corporate profits are and what the outlook for stocks might be.

As Timothy Chubb, chief investment officer at wealth-management firm Girard, points out, investors are increasingly concerned that a recession may be on the horizon. The key question now is what kind of recession we may be facing – a soft landing or a hard landing.

The S&P 500 declined by 19% in the year 2022. However, the start of 2023 has been more positive, with the index rising by 1.4% in the past week. This is after a lighter-than-expected wage-growth reading in Friday’s jobs report suggested that inflation is abating.

This week, investors will be reviewing quarterly results from some of America's biggest banks, including JPMorgan Chase & Co. and Bank of America Corp. They will also be looking at results from companies such as Delta Air Lines Inc. and UnitedHealth Group Inc. In addition, they will be analyzing the latest consumer-price reading, which is likely to have an impact on the Federal Reserve's plans to raise interest rates.

A key question for investors is how long customers will be willing to pay higher prices as companies try to pass on elevated costs. Consumer spending slowed in November ahead of the crucial holiday shopping period, according to the Commerce Department’s latest report. Retailers offered deep seasonal discounts to try to attract thrifty shoppers.

Nike Inc. recently increased its sales outlook for the future, citing progress made in addressing inventory issues. This is just one example of how earnings reports have been mixed recently.

"As long as consumers value our products, we've been able to increase prices to offset rising input costs," Nike CFO Matthew Friend said on the company's earnings call.

Last week, food maker Conagra Brands Inc. posted higher revenue thanks to price increases. The company said it was considering further price increases in the future. Meanwhile, beverage maker Constellation Brands Inc. cut its profit forecast as customers experienced sticker shock at more expensive beer.

Companies are also dealing with higher input costs by reducing personnel. In recent months, big technology companies including Amazon.com Inc., Meta Platforms Inc. and Salesforce Inc. have unveiled mass layoffs to wrangle costs.

Scott Duba, chief investment officer at Prime Capital Investment Advisors, said that he expects to see continued layoff announcements, potentially spreading beyond the tech sector. This is likely to have a negative impact on the economy as a whole.

Mr. Duba said that his firm is planning to use any volatility in markets during earnings season to look for buying opportunities. He added that Prime Capital has been overweight in traditionally defensive sectors like healthcare, consumer staples and utilities, and is thinking about adding to positions in more growth-focused segments like tech.

Analysts expect energy companies to report the highest year-over-year earnings growth among the S&P 500 sectors for the fourth quarter, according to FactSet. They forecast the materials and consumer discretionary segments to experience the greatest profit decline.

Many investors say they have prepared for weaker results based on the significant drop in consensus estimates. Analysts lowered their earnings expectations during the fourth quarter by 6.5%, which is much sharper than the average revision, according to FactSet. This gives companies a lower goal to reach in order to give investors more confidence to buy shares.

Aoifinn Devitt, chief investment officer at Moneta Group, said that her firm is bullish on energy, healthcare and consumer-staples companies going into the earnings season while remaining cautious on the tech industry. Devitt said that there has been a lot of telegraphing in advance, and that Moneta Group is taking a cautious approach to investing in tech companies.

Some investors say that despite the recent revisions to earnings estimates, the outlook for 2023 remains relatively positive. According to FactSet, analysts expect S&P 500 companies' profits to rise by 4.7% this year, which is in line with the expectations for 2022.

If profits start to fall, stocks may look relatively more expensive compared to future earnings. According to FactSet, companies in the S&P 500 are currently trading at around 17 times their projected earnings over the next 12 months, which is roughly in line with the 10-year average.

"We'll remain in a defensive position until we see these estimates reflect the bust," said Mr. Chubb of Girard.