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Weekly Headings

Weekly investment strategy

Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

  • Expect a downward revision in 2022 earnings estimates
  • Market will react most strongly to an earnings miss
  • Buyback activity may be muted for select sectors

The world got its first glance at the capabilities of NASA’s James Webb Space Telescope this week. Roughly one million miles away, the camera was able to capture cosmic cliffs, stellar nurseries, and individual stars that were previously undetected. While the financial markets don’t have a telescope to detect the path of the economy and monetary policy, this second quarter earnings season should at least provide some clarity on how businesses navigated uncertainty over the last three months and more importantly, how CEOs view the outlook for the months ahead. So far, forward looking estimates have been resilient this year despite the sharp decline in equity prices, with full-year earnings expected to be up 10% to $227 while prices are down ~20%. But is there downside from here to earnings? Below we discuss our earnings outlook for the remainder of the year and the 2Q22 earnings season.

  • Full Year Earnings Estimates Will Come Back Down To Earth | Many economists have called for a recession this year, but analysts have been slow to downgrade earnings estimates. We’ve done the opposite. We do not foresee a recession this year (just slower growth) but have adjusted our earnings expectations downward as elevated input prices (and the subsequent impact on margins) and a Fed-induced economic slowdown likely push full year 2022 earnings closer to $220. But even at this level, the S&P 500 would still reflect healthy full-year earnings growth of 6-7%—in line with its historical average. As for the few strategists that have called for earnings to fall to or below $200, we believe this magnitude of downward revisions is unlikely for a few reasons. First, one half of earnings for 2022 is already in the books, and earnings typically correlate to nominal growth that has remained strong in the 5-10% level thus far in 2022. Second, a bottom-up approach from a sector perspective makes it difficult to arrive at earnings below $200. Defensive sectors (Utilities, Health Care, Consumer Staples and Real Estate) account for ~27% of S&P 500 earnings and should only experience modest, if any, downside risk from current levels (~1-3%). Defensive cyclicals (Info Tech, Communication Services, and Financials) could see slightly more at 3-5%, while the bulk of downward revisions (7-12%) is likely to be limited to the cyclical companies (e.g., Consumer Discretionary, Industrials, and Materials) as slowing economic growth will more heavily impact these sectors. The bottom line is that while consensus earnings estimates of $227 are too optimistic, the aforementioned positive dynamics should buffer earnings from contracting to the more extreme calls of $200 or lower.
  • 2Q22 Earnings Season Won’t Shoot For The Stars | The bar for earnings expectations was set high last year, especially when the S&P 500 posted earnings growth of over 90% in 2Q21 as the global economy reopened from its pandemic-induced state. But with the economy operating more fully since, 2Q22 earnings growth will face tough comparisons on a year-over-year basis. In fact, it is expected to be the weakest quarter of earnings growth this year, albeit still positive at 5%. Below are a few of the broad-based and sector level trends we expect to emerge in the weeks ahead:
    • Houston, We Have A Sentiment Problem | With investor sentiment at depressed levels, market reactions to earnings beats and misses will likely be magnified, especially to the downside. In the weeks ahead, the ‘punishment’ or selloff post an earnings miss is likely to outweigh the market’s reaction to an earnings beat. Guidance provided will surely be parsed and scrutinized.
    • Dispersion: Over The Moon Or A Failure To Launch | The torrid pace of economic growth benefitted all sectors last year, but the challenging environment and difficult to beat comparisons will cause dispersion in earnings growth and margins. The Energy sector is expected to be the standout, with healthy margins and earnings forecasted to grow in excess of 260%. In comparison, S&P 500 earnings ex-Energy are expected to be down ~3% and four sectors are expected to have negative EPS growth—the most since 4Q20. Margins of those sectors are expected to modestly contract.
    • Beaming Up Buybacks? | Share buybacks reached a new quarterly record last earnings season—rising 23% above pre-COVID highs. Shareholder-friendly actions have been a critical tailwind for equities over the last 12 months, but some sectors may exercise more caution given the level of uncertainty in the economic outlook. This may be especially true for the Financials sector, as JPMorgan announced a temporary suspension to its repurchase program to better position its reserves in the event of a downturn. Hopefully, this is an exception as aggregate dividend and buyback declarations remain robust.

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All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Past performance may not be indicative of future results.