Earnings season starts next week and, once again, investors will be looking for signs of whether the fundamental strength of individual companies warrants the large advances in stock prices that we’ve seen over the past four years. With the stock market having given up ground in June, the stakes are higher than ever, as doubt has started to creep into investor sentiment. But bulls should take heart in the fact that estimates of earnings growth for the quarter are actually stronger than they’ve been in previous quarters.
The expectations game
At this point, before companies start making their quarterly reports, looking ahead to earnings season is all about two things: overall market sentiment, and any warnings that individual companies have issued. We’ve all seen firsthand how sentiment has shifted in a more negative direction over the past month, as declines in the Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI), as well as broader stock market benchmarks, didn’t immediately give way to buy-on-the-dip rebounds. And, because company warnings tend to be negative, earnings projections often reach their low point right before the season starts.
Yet, even with that negative bias, Thomson Reuters Corporation (USA) (NYSE:TRI) reports that overall second-quarter earnings estimates for the S&P 500 (INDEXSP:.INX) suggest year-over-year growth rates of about 3%. That doesn’t sound like stellar growth, but it’s better than the near-zero growth projections that we’ve seen in previous quarters.
Moreover, at least recently, earnings estimates have tended to reverse course and climb once actual data becomes available. During the first quarter, S&P earnings growth of more than 5% came in almost four percentage points higher than estimates as of the beginning of April, before that particular earnings season began. Add in that same positive movement and, by the time companies finish reporting over the next few months, earnings could jump by 7%.
Where the growth is — and isn’t
Recently, earnings growth has centered on two primary industries: telecom stocks and financials. Again using Thomson Reuters figures, those areas show prospects of about 18% growth for the second quarter. For financials, rising interest rates actually have the potential to help, especially on the insurance side of the business where insurers rely on income from investment portfolios to help defray claim costs. Yet, even for banks, rising net interest spreads have investors excited, with Bank of America Corp (NYSE:BAC) weighing in at more than 30%. Because earnings at Bank of America Corp (NYSE:BAC), and some other banks, have been at depressed levels for some time, overall industry gains might be somewhat misleading, but they still promise to have a substantial impact on S&P earnings overall.