4 major risks facing the stock market as the earnings season kicks off

As investor concerns about slowing US economic growth have manifested in the form of falling commodity prices, while a strong US dollar is affecting the international earnings of US multinationals, according to analysts at Bank of America Global Research BAC,
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Other sell-side research shops have highlighted the following paradox: Expectations for corporate earnings growth remain relatively strong, even as analysts fear that inflation and tightening financial conditions could trigger a recession before the end of the year.

Given the difficult performance that US stocks have suffered this year, many downtrodden investors are hoping that strong corporate results (at least, relative to expectations) will spur a lasting recovery in US stocks. Others fear the disappointment may remove one of the recent support for US stocks as corporate earnings saw a lasting post-COVID recovery and exceeded expectations during the first quarter of 2022.

Forecast for quarterly growth in earnings per share for the S&P 500 SPX,
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It rose to 5.5% as of Monday, compared to 5.3% as of a month ago, according to S&P Global Market Intelligence. According to data from FactSet, earnings for the first 18 S&P 500 companies were stronger than expected – but the bulk of corporate earnings, including the most valuable members of the market-weighted benchmark index, still await them.

That will start to change later this week. “Earnings season” – as analysts call it – begins Thursday with JP Morgan Chase & Co. , JPM,
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And a large number of reports from the largest US banks. By July 29, more than 70% of Standard & Poor’s 500 customers will have announced second-quarter results.

Although quarterly earnings for S&P 500 companies typically exceed expectations, FactSet indicated that simply meeting earnings expectations during April, May and June would leave US companies with the slowest earnings growth since the fourth quarter of 2020.

However, as investors prepare for the earnings torrent ahead, MarketWatch has put together a brief report on what some of the major investment banks are telling their clients ahead of the quarterly earnings deluge, which begins Thursday with reports from JP Morgan Chase & Co.

is reading: Wall Street profit expectations for large banks fell before profits were made amid a deep freeze in stocks

Strong Dollar Brings Risks

Morgan Stanley MS,
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Chief equity strategist Michael Wilson received plenty of credit for correctly calling it a stock sale this year (he was one of the most skeptical voices on Wall Street during most of the COVID rally, too). Looking ahead, it remains bearish, warning clients in a research note dated Monday that a strong dollar could create an unexpectedly large tailwind for corporate earnings in the second quarter.

In all, US companies generate about 30% of their sales abroad. A strong dollar means that companies lose money against the exchange rate, while the cost of hedging increases their risk.

“From an equity point of view, a stronger dollar would be a major headwind to earnings for many large multinationals. This could not come at a worse time as companies are already struggling with margin pressures from cost inflation, high/junk stocks and slowing demand,” Wilson wrote. and his team.

Noting a negative correlation between S&P 500 earnings reviews and a stronger dollar, Wilson said the math here is relatively simple: Each percentage point increase in the dollar year-over-year results in roughly 0.5 percentage points hitting EPS growth. . At 16% today on an annual basis, this
Translates to the opposite 8 percentage points, all else being equal.

Recession risks shifted toward later in the year

A group of stock strategists led by C from Citigroup,
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Scott Kronert wrote in a note on Friday that they expect the US economic picture in the second half of 2022 to be more robust, with a recession likely in 2023. If second-quarter earnings prove as resilient as Citi expects, it could lead to a rally in stocks. Short-term in what the Citi team described as year-end “average retracement” trading.

They also argued that rising inflation that began about a year ago likely helped drive corporate profits, as companies could charge more for their products and services. There is also a strong correlation between corporate earnings growth and higher interest rates at the Fed, with corporate earnings slowing as the central bank starts cutting rates, and higher when rates are increased.

‘Difficult companies’ can also be a problem

As a CS for Credit Suisse,
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Jonathan Golub noted that corporate profits increased by an astonishing amount during the second quarter of 2021 as global economic reopening accelerated to a peak. According to FactSet, the S&P 500 EPS rose more than 90% during the second quarter of 2021. This means that this year’s quarter will be hard to beat.

The company’s performance in each quarter is ultimately judged by its performance during the same quarter a year ago. The strength of last year’s second quarter means that the S&P 500 companies face “difficult companies” this year, especially with expected EPS growth of just 5%.

The setting looks better for the third and fourth quarter.

Margin pressure is a threat

Another threat to corporate profits is “margin pressure” – that is, when profit margins shrink, even as overall sales rise. It is difficult to avoid during periods of hyperinflation.

According to a team of analysts led by Goldman Sachs Group Inc. p,
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Sales of S&P 500 companies are expected to grow 15% during the second quarter thanks to the support provided by inflation, a US equity strategist. However, higher input prices, wages and borrowing costs mean that profit margins are expected to shrink 18 basis points to 12.2%.

What’s more, if one excludes a 239% increase in energy sector profits, then corporate profits are expected to see a 3% contraction during 2022.

Analysts at both Bank of America and Goldman Sachs said they expect EPS growth to likely slow during the second quarter due to the strength of the dollar and turmoil in the US economy.

To be sure, corporate earnings aren’t the only highlights of the economic calendar that may affect the markets this week. On the inflation front, the Labor Department’s consumer price index for June is due on Wednesday. The market will be watching closely, and while the data won’t reflect a full drop in commodity prices over the past five weeks, it could affect the Fed’s plans to raise interest rates. In recent weeks, the expectation that slowing growth will lower commodity prices has prompted investors and economists alike to back off their expectations for the Fed’s lifting cycle. According to FactSet, the consensus expects general inflation to rise 8.8% year-on-year, which would be higher than the 8.6% rate recorded in May.

On Monday, US stocks were trading lower, with the S&P 500 down 0.8% to 3,867, the Dow Jones Industrial Average,
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0.2% discount at 31271 and the Nasdaq Composite,
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down 1.7% at 11,437. US benchmarks are down 18.9%, 13.9% and 19.7% so far this year, respectively.

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