Will the US stock market face its worst earnings season in three years? Wall Street's Consensus on Exploring "Alpha" Opportunities | Market | Financial Reports

Concerns have resurfaced that the Federal Reserve's path to fighting inflation is far from over, and the US stock market has suffered a disappointing start to the second half of the year. Entering this week, the market will face another test, which is the upcoming US stock market earnings season. This week, in addition to major US banks such as JPMorgan Chase and Citigroup continuing to lead the way, Delta Air Lines and PepsiCo will also disclose their latest transcripts.

The market generally believes that due to the negative impact of macroeconomic headwinds, US listed companies will hand over their worst performance in three years. Can the US stock market hold on under pressure on corporate profits?

Morgan Stanley stock strategist Andrew Bock told First Financial reporters, "The almost 100% return rate so far this year has been driven by the expansion of P/E multiples, and the market is either not concerned about profitability or expects significant growth later this year and next year. Some may believe that the Fed's end to rate hikes will be the support of this expectation, but various signs suggest that the Fed will raise rates at least once again within the year, as the market is currently betting."

Market consensus predicts that the second quarter will be the bottom of corporate profit growth rate

Profit growth rate is expected to hit bottom

For over a year, American companies have been battling stubborn inflation, weak consumer demand, and the Federal Reserve's interest rate hikes. As a new wave of corporate financial reports is about to be released, investors will focus on the profitability of the company and use it to measure whether the current valuation of the US stock market is inflated.

Some market participants are concerned that the gains in US stocks from the beginning of the year to date have deviated from fundamentals, and may become unsustainable after the optimistic sentiment surrounding the prospects of artificial intelligence fades. In the first half of the year, the S&P 500 index accumulated a 15% increase, and the Nasdaq Composite Index, mainly composed of technology stocks, surged nearly 32%, marking the best start in 40 years.

Analysts predict that quarterly profits of companies in the S&P 500 index will decline for the third consecutive quarter. According to the data of FactSet, as of July 7, the market consensus predicted that the earnings per share of the S&P 500 Index in the second quarter would decline 7.2% year on year, which would be the largest decline since the second quarter of 2020. At that time, when the COVID-19 occurred, corporate profits dropped by 32%.

Other market insiders believe that the dismal expectations given by Wall Street analysts are equivalent to setting a very low threshold for companies to surpass, which may give investors more confidence to buy at the bottom. "It's hard to get injured when you fall from the basement window," said Sam Stovall, chief investment strategist at CFRA Research. The market has already digested the risk of continued decline in profits, which surprised investors even better than expected.

Bock told First Financial reporters that the market consensus has postponed the time point for the bottom of earnings per share growth to the second quarter. However, before the start of the first quarter financial reporting season, the first quarter was considered a trough, which means that this trend may continue. Morgan Stanley's model based on profit leadership indicators also shows that the bottom of corporate profit growth has not yet arrived.

However, FactSet data shows that the profits of S&P 500 index constituent companies are expected to increase by about 0.3% in the third quarter and by about 8% in the fourth quarter. Bock believes that the key to influencing stock market trends will come from companies providing guidance for the third quarter, rather than the performance of the second quarter itself.

Where is the opportunity for Alpha?

The US June non farm payroll report released last Friday showed that the US wage growth rate continued to be higher than expected, consolidating the market's bet on the Federal Reserve's interest rate hike this month. If interest rates continue to rise, business operations will undoubtedly face greater pressure. In a situation where consumers are already suffering from inflation, it is questioned whether companies can continue to pass on the pressure of rising costs. Analysts predict that the revenue of companies in the S&P 500 index will decline by 0.3% year-on-year in the second quarter, marking the first decline since the third quarter of 2020.

Previous quarterly reports have shown that some companies are struggling under inflationary pressure. For example, General Mills announced in June that its first quarter sales were hit and sales have also weakened. Carnival Cruise, the world's largest cruise company, said that due to rising costs, it is expected that costs will exceed previous estimates this year. Pharmaceutical retail giant Wobo Lian has lowered its performance outlook for this year amid sluggish consumer spending. "Frankly speaking, the interaction between interest rate environment and economic slowdown expectations on consumer behavior is a very prominent and important variable in our performance guidance," said Kofi Bruce, Chief Financial Officer of General Mills, at the Q1 earnings briefing

According to FactSet data, market consensus predicts that the non essential consumer goods sector in the S&P 500 index will have the highest year-on-year profit growth rate, reaching 27%, with Amazon contributing the most. The profit decline in the energy sector is the most significant, reversing last year's situation.

"In short, this financial reporting quarter is more important than the previous two quarters, and it is an opportunity for both bulls and bears to explore the 'alpha'," Bock told a reporter from First Financial