Markets have muted reaction to earnings beats
Q2 earnings season is coming to a close, but it’s been a bit overshadowed by the Fitch downgrade of U.S. credit (which we wrote about a week ago) and this week China’s economic downturn.
In line with typical results, nearly 80% of companies have beat earnings expectations. However, the market hasn’t rewarded these companies as much as normal – they’ve only seen a half a percent gain (top orange bar) vs. the 10-year average of around 1.6% (green bar).
Investors typically punished companies that missed earnings estimates (middle bars). Interestingly, this quarter even companies that met earnings expectations (bottom bars) have been punished more than usual.
So overall, the market seems to be a little pessimistic about earnings – especially for companies meeting or beating expectations.
Q2 earnings slowdown not as bad as expected
Remember just a month ago estimates were for earnings to shrink 9% YoY. With more than 90% of S&P 500 firms having reported earnings, we’re on track for earnings to fall 4.9% YoY (chart below, orange bar).
So the actual decline is also only about half as bad as feared.
And the weakness is really limited to just three categories (chart below, red bars): Energy (lower energy prices), Materials (falling goods demand), and Health Care (drop in Covid-related spending).
All 8 other sectors saw positive growth (green bars), led by the consumer revenge spending in Consumer Discretionary (+53%, hotels and restaurants), Communication Services (+19%, entertainment and big tech), and Industrials (+12%, airlines).
What we see when we look in more detail at earnings are
- Sales have been rising for a year and a half (chart below, black line), as consumer spending continues.
- Earnings (profits) have started to recover, after some margin compression caused by wage growth and more competition for products once inventories were rebuilt. However, more recently (green circle), EPS has moved back near previous highs, supporting stock valuations and a recovery from the Earnings recession.
Consumer-led earnings consistent with rebounding consumer spending
That’s all consistent with what we’ve seen from spending data this week.
Yesterday, data showed retail sales increasing 0.7% in July from June, as consumers spent money online (boosted by Prime Day), on recreation (helped by “Barbenheimer” and Taylor Swift, look what she made you all do!), and at restaurants.
But this is part of a larger trend. Retail sales, even after adjusting for inflation (see real line in chart below), have increased for four straight months.
What might slow the consumer down
Two things that might slow the consumer down are:
- Record Credit Card debt: Credit card debt passed the $1 trillion (chart below) – an increase of 30+% in the last two years – a sign that consumers are running out of savings. Also note the average credit card interest rate is now over 20%.
- Student Loan repayment restarts: Some 20 million Americans will also have to start repaying student loans in October, and a recent poll shows 56% say they’ll be buying less essentials.
Still, economists have been forecasting that the consumer will run out of spending power for months now – and it still hasn’t happened.
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