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Breaking Down Earnings Amid Fed Tightening, Economic Slowdown Fears

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It is reasonable for earnings estimates to be coming down in the face of Fed tightening. The reason for that is the ‘second-derivative’ effect, with higher interest rates resulting in slower economic growth, which in turn shows up in moderating revenue growth.

There are some in the market that can’t see the Fed getting on top of the inflation problem without pushing the economy into a recession. Variations of this view show up in public comments from business leaders along the lines of Jamie Dimon’s ‘hurricane’ comment and Elon Musk’s ‘super bad feeling’ about the economy.

A recessionary outcome for the economy is neither the consensus view, nor what the Zacks economic team is projecting at present. What everyone agrees on, however, is that the economy should start slowing as the cumulative effect of higher interest rates seep through into the economy.

We are not there yet, as the better-than-expected May jobs report showed on Friday. But we are starting to see some tell-tale signs of moderation, with some companies announcing hiring freezes or even lay-offs. Even the strong May jobs report showed some deceleration in wage gains. It is still early, but these signs suggest that the Fed’s actions are steering the economy in the desirable direction.

To get back to the ‘second-derivative’ effect of moderating economic growth, we note that while earnings estimates have come down a bit, they are nowhere near what would be consistent with a significant economic slowdown.

For example, 2022 Q2 earnings for the S&P 500 index companies are currently expected to increase +2.1% from the year-earlier level on +9.5% higher revenues.

If we look at the revisions trend in the aggregate, at the S&P 500 level, we don’t see a lot of movement, as you can see in the chart below that plots the evolution of aggregate Q2 earnings growth estimates for the index since the start of 2022.

Zacks Investment Research
Image Source: Zacks Investment Research

What this chart shows is that expected Q2 earnings growth in the aggregate has declined from +2.8% on March 30th to +2.1% today.

That said, there are plenty of cross currents at the sector level, with positive revisions to the Energy sector offsetting declines in most other sectors.

Second quarter 2022 earnings estimates for the Zacks Energy sector have increased +45.2% since the start of April.

Energy is not the only sector that has enjoyed positive Q2 estimate revisions; there are 5 other sectors whose estimates have gone up in varying magnitudes. Since the start of Q2 on April 1st, earnings estimates have gone up for the Transportation, Basic Materials, Autos, Construction, and Consumer Staples sectors. Of these 5 sectors, the upgrade to the Q2 earnings outlook is particularly significant for the Transportation and Basic Materials sectors.

If we look at the aggregate Q2 revisions, after excluding the Energy sector from the mix, then the picture changes, as you can see below.

Zacks Investment Research
Image Source: Zacks Investment Research

Pretty much the same trend is at play with the revisions trend on an annul basis, with aggregate estimates stable or even modestly up since the start of the year, but starting to come down on an ex-Energy basis.

I will not share those charts here to keep the length of this piece manageable, but I think it will be useful for you to see what has happened to full-year 2022 earnings estimates for the Energy sector since the start of the year.

Zacks Investment Research
Image Source: Zacks Investment Research

Any way you look at it, the Energy sector is in a good place at present, with a very strong earnings outlook, as a relatively long-term view of the sector’s earnings picture shows below.

Zacks Investment Research
Image Source: Zacks Investment Research

This Week’s Earnings Results

For all practical purposes, the 2022 Q1 earnings season has come to an end. But it isn’t over yet, with three S&P 500 members on deck to report Q1 results this week. These are JM Smucker (SJM), Campbell Soup (CPB) and Brown-Forman (BF).

With results from 496 S&P 500 members already out, we will only have Kroger (KR - Free Report) left after this week’s results from these three index members. In fact, the day Kroger reports its quarterly results on June 16th, Adobe (ADBE) will be releasing its fiscal May-quarter results that we count as part of the 2022 Q2 tally.

The Current Earnings Backdrop

The chart below shows current expectations (and actuals) on a quarterly basis.

Zacks Investment Research
Image Source: Zacks Investment Research

The chart below shows the comparable picture on an annual basis.

Zacks Investment Research
Image Source: Zacks Investment Research

For a detailed look at the overall earnings picture, including expectations for the coming periods, please check out our weekly Earnings Trends report >>>>Breaking Down the Tech Sector’s Earnings Outlook 

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