The Q2 earnings season is upon us, and investors are keenly watching to see how Corporate America performs after a strong Q1. Bank of America strategists have provided a comprehensive preview of what to expect, and their insights are invaluable for understanding the current economic landscape.
Q1 2023 Earnings Recap
In the first quarter of 2023, companies exceeded expectations with a 3% earnings per share (EPS) beat. This impressive performance was partly due to easier year-over-year comparisons. Specifically, Q1 saw a 3% decline, while Q2 2023 is expected to reflect a 6% decline, making Q1’s results appear stronger in contrast.
Expectations for Q2 2023
For Q2, BofA strategists predict a 2% earnings beat, which aligns with historical averages but is the smallest since Q4 2022. This modest expectation comes despite the more challenging macroeconomic conditions compared to Q1.
Macroeconomic Conditions
The Economic Surprise Index (ESI), which measures how economic data compares to forecasts, has reached its lowest point since June 2015. This low ESI suggests a potential 3% miss in Q2 earnings. However, historical data offers some hope.
Historical Data and Optimism
Looking back at post-global financial crisis data, EPS have beaten expectations 91% of the time when the ESI was negative, with an average beat of 3%. This track record suggests that despite the low ESI, an EPS miss remains unlikely.
Analyst Confidence and Estimates
Interestingly, analysts have not revised their earnings estimates downward since March, which is unusual. Typically, earnings estimates are cut by about 4% leading up to earnings. This stability indicates a high level of confidence in the forecasts.
Earnings Revision Ratio and Guidance Ratio
BofA reports improvements in both the earnings revision ratio and the guidance ratio for Q2. These indicators suggest that growth is holding steady, despite some headwinds.
Foreign Exchange Impact
One of the significant challenges this quarter is the impact of foreign exchange (FX) rates. BofA estimates that FX has created a 100 basis point headwind to sales, the largest since Q1 2023. This factor will be crucial to watch as earnings reports come in.
Growth Dynamics in Q2
A notable trend for Q2 is the expected EPS growth for the “Other 493” companies in the S&P 500, excluding the “Magnificent 7” (the top tech companies). This will be the first EPS growth for these companies since Q4 2022. Conversely, the “Magnificent 7” are expected to see their growth slow for the second consecutive quarter.
Market Implications
The broadening of growth beyond the top tech companies suggests a more diverse market expansion. This shift could have significant implications for investors looking to diversify their portfolios.
Demand and Inflation
BofA’s strategists highlight that demand, not inflation, is the primary driver of earnings. For the second half of the year, a modest real sales growth of just 1% is expected, excluding the “Magnificent 7”. This conservative outlook is supported by the end of the sharp de-stocking cycle.
Inventory Correction Phase
The ratio of new orders to inventories has improved, signaling the nearing end of the inventory correction phase. This improvement is a positive sign for future growth.
Q4 2023 EPS Growth Expectations
Looking ahead to Q4, BofA expects 14% EPS growth. This high figure is driven by specific sectors, including Health Care, Financials, and the “Magnificent 7”. Non-recurring expenses in Health Care from the previous year also contribute to this optimistic outlook.
Impact of AI Investments
The upcoming earnings season will provide new insights into the impact of AI investments. While the monetization of AI may take longer than initially anticipated, major tech companies continue to invest heavily. Consensus forecasts a 34% increase in capital expenditure (capex) from hyperscalers in 2024, amounting to approximately $200 billion.
As we head into the Q2 earnings season, there is a blend of cautious optimism and realistic expectations. While macroeconomic conditions pose challenges, historical data and stable analyst estimates provide a foundation for hope. Investors should watch for shifts in growth dynamics, the impact of FX rates, and continued investments in AI. This earnings season promises to be insightful, offering a clearer picture of Corporate America’s resilience and adaptability.
What is the Economic Surprise Index (ESI)?
The ESI measures how economic data compares to forecasts. A negative ESI indicates that economic data is coming in below expectations.
Who are the “Magnificent 7”?
The “Magnificent 7” refers to the top tech companies in the S&P 500, known for their significant market influence.
Why are analysts confident in their earnings estimates for Q2?
Analysts have maintained their estimates since March, which is unusual as estimates are typically revised downward. This stability indicates a high level of confidence.
What is the significance of the inventory correction phase?
The end of the inventory correction phase, indicated by the improved ratio of new orders to inventories, suggests that the sharp de-stocking cycle is nearing its end, which is positive for future growth.
How are AI investments expected to impact future earnings?
AI investments are expected to increase significantly, with a 34% rise in capital expenditure forecasted for 2024. This continued investment, despite delayed monetization, indicates the early stages of an AI investment cycle.
