Third-quarter earnings season starts this week and investors hope their favorite stocks report record profits. However, the vast majority of estimates tell us it isn't going to happen. In fact, earnings are expected to grow less than in the second quarter. More importantly, without the energy sector, annual earnings growth may decline across the board.
This paints an ugly picture for the economy while raising the potential for a prolonged recession, marking the worst performance since Q3 2020. As a result, it's wise to expect more companies to withdraw bullish guidance, or to revise earnings and revenue forecasts downward. A number of top names already have.
Expectations for S&P 500 third-quarter earnings growth peaked in late June at 11.4%, and have since dropped to 4.5%, according to Refinitiv. FactSet estimates are even lower, at an estimated 2.4% growth rate.
Regardless of the data set, both forecast a sharp decline on Q3 earnings estimates and poor outlook for the rest of the year.
"Earnings growth ex-energy has turned negative since August and now reads a negative 2%. That would mark the second consecutive quarter of negative ex-energy year-over-year growth," said Tajinder Dhillon, a senior analyst at Refinitiv.
"This would mark a 'turning point' as we've only seen ex-energy earnings growth turn negative in two prior periods — the global financial crisis of 2008-2009 and the Covid pandemic of 2020."
Energy Sector Earnings Growth Also Seen Declining
The S&P Energy Select Sector ETF has returned 44% this year vs. negative 25% for the S&P 500.
The energy sector, which includes big oil stocks, is expected to contribute 6.3% toward the overall Q3 earnings growth rate of 4.5%. In other words, the group's contribution to profits may be greater than all other sectors combined.
At the other end of the spectrum, the communications and financial sectors are predicted to be the quarter's biggest losers.
Ominously, the energy sector's earnings growth rate has lost altitude since peaking earlier this year and is now expected to post a 14.3% decline quarter over quarter. That would mark the first quarterly decline since Q1 2021.
The deceleration could put further pressure on broad-based earnings growth in the third quarter and future quarters.
But Brad McMillan, chief investment officer for Commonwealth Financial Network, points out that estimated earnings growth tends to undercut what companies actually report. According to FactSet, reported earnings have beaten expectations in 39 of 40 quarters in the past 10 years.
"Although the economy isn't as bad as expected, it is slowing in many ways," McMillan said. "And even though we can expect earnings to do better than expected, the inflation and labor drag is very real, as is the foreign exchange effect. All of these will weigh on earnings, although likely not as much as currently estimated."
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