A Bumpy Road for Corporate Earnings

Investment Insights: Market Update
  • Much of the stock rally this year has been concentrated in communication services and info tech sectors, which are up over 20 percent.
  • Wall Street predicts earnings will fall again, declining by 6.5 percent in the first quarter amid slumping government spending and private investment.
  • Multinational corporations should fare significantly better than more domestic counterparts as a weakening US dollar benefits international markets.
  • S&P 500 company earnings are expected to decline again in the second quarter as well, but may see a strong rebound in the latter part of 2023.

Investors appear to be back in the regular swing of things. This is despite reservations over the banking system debacle and concerns about the Federal Reserve's campaign against inflation potentially—and finally—ending. Given that newfound sense of ease, US stocks have regained ground and are up over 8 percent this year, according to the S&P 500 Index. A majority of those gains are concentrated in the communication services and info tech sectors, which are up over 20 percent each, with most other sectors fluctuating between positive and negative single-digit returns. However, there may be more bumps in the road ahead. As rate hikes percolate through the financial system, expectations for a slowing economy are still in play and have begun to have a larger effect on corporate profitability predictions.

Market focus has shifted to corporate earnings season as first-quarter results trickle in. Expectations are less than enthusiastic as analysts attempt to factor in slumping government spending and private investment for the quarter. Wall Street is forecasting S&P 500 company earnings will contract by 6.5 percent in Q1 2023 compared to the same time last year. That would be an 11 percent decline from the earnings peak in Q2 2022. But when inflation is included, the decline grows to 14.6 percent. While most sectors will likely see an annualized decline, if estimates are to be believed, consumer discretionary and industrials sectors will buck the trend with double-digit growth in the first quarter. Interestingly, this quarter will be divisive for multinationals. Companies that obtain less than half of their revenue overseas are expected to see earnings decline by almost 17 percent, while more international peers may only weaken by 0.3 percent. Domestic headwinds seem to be on the rise, and a weakening US dollar is benefitting international markets.

While a second consecutive earnings decline is likely on the way, it probably won't be as bad as predictions say. Companies have a long track record of outperforming analyst estimates, which could bring the actual decline to just one or two percent. So far, S&P 500 companies are beating estimates by 6 percent, with actual earnings growth up 2.9 percent—though it's much too early to call yet. Looking forward, next quarter may not be much better. Wall Street analysts are forecasting another decline in earnings, down 4.6 percent. However, predictions get much rosier after that, with positive growth of 1.9 percent in the third quarter and then a strong rebound of 8.8 percent earnings growth in the fourth quarter of 2023. There are growing headwinds for corporate earnings, but it may be smooth sailing after a few more bumps in the road.

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Financial market data for various time periods covering global asset classes. Data as of April 18, 2023.

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