Welcome to the Last Hurrah for US Earnings

The US is also coming off a second-quarter earnings season that most interpreted as surprisingly adequate, with the outcome helping drive the 17% bear market rally over the summer, the biggest of the year. Analysts expect S&P 500 adjusted earnings per share to be $55.67 for the third quarter, up 2.6% from the period a year earlier. Of course, that partially reflects the strength of oil prices. Excluding energy companies, analysts’ estimates would imply a 3.9% contraction from a year ago.

So why is everyone so skittish about earnings again? In the near term, the risks are mostly related to bloated inventories and the strength of the US dollar. In the wake of the supply chain shocks that now appear to have peaked, companies are saddled with packed warehouses and full shelves just as consumers are growing exhausted with inflation, which is translating into steep discounts in some cases. According to Morgan Stanley analysts including Michelle Weaver, consumer retail and tech hardware probably face the greatest threat.

The strength of the dollar is another risk for the third quarter, albeit one that should be accounted for in asset prices. About 31% of S&P 500 revenue comes from overseas, down significantly from the 2012 high of 36%, according to Bloomberg Intelligence, and my BI colleague Michael Casper estimates that a 1% appreciation in the greenback translates into a 12-basis-point drag on earnings per share. After the 19% advance in the past year, that translates to a drag of about 2.3 percentage points as multinational companies convert foreign earnings into dollars. All of that being said, analysts have already dropped adjusted third-quarter earnings-per-share estimates by about 7.7% since early June, which may leave room for upside surprises.

The outlook for the fourth quarter and 2023 are less rosy, which goes to the heart of the concerns about earnings season: Investors fear the comments that management will issue about the future. Even by its own optimistic projections, the Federal Reserve’s interest-rate increases are likely to push up unemployment next year to 4.4% from the current 3.5%, a magnitude of increase that historically tends to beget even more job losses — unemployment increases don’t come in medium-sized junks; they tend to snowball. It’s disconcerting to imagine how US consumption, which is hanging on by a thread, will react when people start to lose their jobs in significant numbers. Until recently, consumers have been willing to turn to credit cards to maintain their purchasing power, but they will probably grow more reticent as savings accounts start to dwindle and their employment status is on shakier ground.

Manufacturing may soon become a significant headwind as well. The Institute for Supply Management’s gauge of US manufacturing fell in September to the lowest since May 2020. At 50.9, it’s now within a hair of the 50 index level that separates expansion and contraction.

But with all of that looming, nothing has broken down drastically in the US economy to date — except perhaps the housing market — which means there’s still room for another quarter of positive earnings surprises before the US economy faces its moment of truth. Just don’t expect the market to cheer the small victories this time as they did over the summer. There are just too many concerns about the future to get too carried away with the successes of the past.

Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

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