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An Early Glance Into Q2 Earnings

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The May jobs report showed once again how resilient and stable the U.S. labor market and economy continue to be, defying skeptics that have been warning us of dire economic developments ahead. The decelerating trend in the May wage growth numbers shows that a ‘soft-landing’ scenario is not just wishful thinking but rather a realistic expectation for the U.S. economy.

The labor market is hardly the only part of the economy that continues to defy the skeptics, forcing them to keep delaying the onset of what they see as the day of reckoning. Regular readers of our corporate earnings commentary know that we have been flagging the continued resilience of corporate profitability for a while.  

The 2023 Q1 earnings reports showed us that contrary to fears of an impending earnings cliff, companies were largely able to protect their bottom lines. We are not suggesting that the earnings picture from the Q1 reporting cycle was great, but rather that it proved to be a lot more stable and resilient than many had been willing to give it credit.

We see this recent earnings performance as the appropriate setup as we look ahead to the 2023 Q2 earnings season, whose early reports have started coming in already.  On that count, we are referring to the recent Costco (COST - Free Report) and AutoZone (AZO - Free Report) releases for their fiscal periods ending May that we and other data vendors count as part of the June-quarter earnings tally. 

We don’t want to come across as making light of the macroeconomic uncertainties that are prompting many in the market to be penciling in recessionary outcomes in the next few quarters. We are not saying those expectations are wrong, but rather that we appreciate the economy and corporate sector’s resilience and see lower odds of such dire economic outcomes on the horizon.

All of this has direct implications for the health of corporate profitability.

To get a sense of what is currently expected, take a look at the chart below that shows current earnings and revenue growth expectations for the S&P 500 index for 2023 Q2 and the following three quarters and actual results for the preceding four quarters.

Zacks Investment Research
Image Source: Zacks Investment Research

As you can see above, 2023 Q2 earnings are expected to be down -8.6% on -0.6% lower revenues.

To give you a sense of how much these expectations have evolved over the last three months, the -8.6% earnings decline in Q2 today is down from the -7.2% decline that was expected on March 10th, 2023. Estimates for the last two quarters of the year have similarly come down very modestly over the same time period, with 2023 Q3 down from +0.3% earnings growth on March 10th to a decline of -0.4% today and Q4 down from +7.9% then to +5.6% today.

Please note that while 2023 Q2 estimates have come down, the magnitude of negative revisions compares favorably to what we saw in the comparable periods of the preceding couple of quarters. In other words, estimates haven’t fallen as much as they did the last few quarters, not only for Q2 but also for the rest of the year.

In fact, our regular readers have likely noted that we have been pointing out a notable stabilization in the revisions front lately, which roughly coincided with the start of Q2 in April 2023. This was a shift in the overall revisions trend, which was persistently negative for almost a year. 

Getting back to the 2023 Q2 expectations, embedded in the aforementioned earnings and revenue growth projections is the expectation of continued margin pressures, which has been a recurring theme in recent quarters.

The chart below shows the year-over-year change in net margins for the S&P 500 index.

Zacks Investment Research
Image Source: Zacks Investment Research

As you can see above, 2023 Q2 will be the 6th consecutive quarter of declining margins for the S&P 500 index.

Margins in Q2 are expected to be below the year-earlier level for 11 of the 16 Zacks sectors, with the most significant margin pressures expected to be in the Basic Materials (-382 basis points decline), Construction (-375 bps), Energy (-369 bps), Medical (-248 bps), Conglomerates (-201 bps), Autos (-102 bps), Aerospace (-93 bps), and Tech (-89 bps).

On the positive side, the Finance sector is the only one expected to experience significant margin gains (up +112 bps), with the Consumer Discretionary sector as a distant second (+40 bps). Sectors expected to be essentially flat margins relative to 2022 Q2 are Retail (+7 bps), Utilities (+18 bps), and Industrial Products (+1 bps).

The chart below shows the earnings and revenue growth picture on an annual basis.

Zacks Investment Research
Image Source: Zacks Investment Research

As noted earlier in the context of discussing the revisions trend about 2023 Q2 estimates, we have been observing a notable stabilization in the revisions trend since the start of April 2023.

This stabilization in 2023 earnings estimates represented a notable reversal in the persistently negative trend that had been in place for almost a year since estimates peaked in April 2022. Current expectations for 2023, as represented by the above chart, are down almost -13% since the April 2022 peak.

Since the start of 2023 Q2 in April, aggregate earnings estimates for 2023 are essentially flat, with 8 of the 16 Zacks sectors enjoying positive estimate revisions in that time period. Sectors enjoying positive estimate revisions since the start of Q2 include Construction, Industrial Products, Autos, Tech, and Retail.

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


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