After three straight quarters of year-over-year earnings declines, expectations are for an improved third-quarter earnings season. While consensus forecasts are for a slight year-over-year decline in earnings, economic growth improved in the quarter, and inflation has moderated. Earnings are slated to decline by -0.1% year-over-year, and topline sales are expected to grow by 1.6%. In any case, the last quarter should mark the low in earnings contraction. While the pace of inflation has moderated, the ability of companies to pass on higher prices to protect profit margins will be closely scrutinized. Economic growth looked robust in the third quarter, but the strong job growth reported last week makes another short-term interest rate by the Federal Reserve by year-end more likely. Given the unsettled economic outlook, forward earnings guidance will be crucial.
Twelve S&P 500 companies are scheduled to report earnings in the coming week, but the primary focus will be the kickoff of bank earnings on Friday. There are a handful of other companies like Delta Air Lines
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According to FactSet, the consensus year-over-year earnings estimates for financials are an increase of 9.1%. The impact of the sharp rise in yields on the banks will be closely monitored, including the risk of a reignition of this year’s banking crisis. The pace of loan growth has been weak, which could weigh on future earnings expectations. Credit losses have been normalizing, so the banks will likely increase reserves to prepare for future losses. On a more positive note, capital markets business may have picked up. Insurance companies should post strong earnings growth with some benefits from easier comparisons and higher yields.
The communications services sector should report the most robust year-over-year earnings growth at 31.9%. Meta Platforms
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Oil and natural gas prices are lower year-over-year, resulting in the most significant expected decline in year-over-year sector revenues for the energy industry. With the sharp contraction in sales, energy companies are also likely to have the most considerable year-over-year decline in earnings this quarter. While still clearly meaningful, the pace of price declines for energy products has moderated from the previous quarter. The reduction in energy costs hurts the revenues of the energy sector but positively impacts the costs for many non-energy companies. Labor costs will be a headwind for companies but have also moderated, with average hourly earnings rising at a 4.2% year-over-year rate in September.
Despite the continued plunge in profits due to lower oil prices, two of Berkshire Hathaway’s (BRKA, BRKB) largest publicly traded stock holdings are Occidental Petroleum
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Sales growth is typically closely tied to nominal GDP growth, combining after-inflation economic growth (real GDP) with inflation. Nominal GDP growth had been decelerating year-over-year, but more vigorous economic activity in the third quarter should provide a boost. This trend change supports the consensus estimate of a 1.6% year-over-year sales increase for the S&P 500 and could provide some upside.
Unfortunately, most of the past nominal GDP growth was inflation rather than actual growth. Inflation has been trending lower since mid-2022, which should help earnings turn the corner this quarter. Inflation pressures companies to raise prices or risk lower profit margins as their costs rise.
Looking at the differential in price growth for producer’s inputs (PPI) versus the price increases hitting consumers indicates some relief on profit margins could arrive this quarter. The better-expected topline sales growth fueled by robust economic activity in the quarter, combined with some easing of margin pressures, allows the opportunity for earnings to grow year-over-year rather than the slight expected decline.
The U.S. dollar should also provide some relief for multinational companies. With approximately 40% of the sales of S&P 500 companies coming from international sources, the dollar weakness provides a relative profit boost to companies selling products internationally.
The expectations of earnings declining modestly year-over-year seem likely to be exceeded and, importantly, should snap the streak of declines. Much attention should be paid to management’s future earnings guidance with the economic outlook unsettled and the specter of at least one more additional rate hike from the Federal Reserve. Given the strong returns from artificial intelligence (AI) exposed companies, the recognition of actual AI-related earnings will be closely scrutinized. Lastly, the sharp rise in real, after-inflation, bond yields has weighed heavily on stocks recently so better earnings would be a crucial counter to that drag.
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