SPMD - The Earnings Season Will Set The Market Direction

• Earnings season will kick off on the 12th of July and end in August.
• Companies are expected to show the lowest EPS YoY growth rate in years.
• The impact of inflation, supply chain problems, and a slowdown in the global economy as a whole on corporate results is the main thing investors want to know about.
• The results of just one sector are likely to decide the way this earnings season goes.
• This earnings season is too big to be bad.

S&P 500 (NYSE: SPY ) just had the worst half in 50 years. Investors' fears over the macroeconomic environment and possible recession dropped the market as Wall Street expects corporate profits to drop massively.

Some analysts say that it is possible for the market to recover faster than usual. To do so, we need some massive catalyst. A strong quarterly earnings season might be the driver that investors are looking for.

Q2 earnings season

The second calendar quarter officially ended on the 31st of May, the earnings season usually starts two months later. We can call the start of the season on the 12th of July with PepsiCo (NASDAQ: PEP ) posting Q2 results. The peak activity will be seen in the last week of July and in the first week of August with 350 companies (70% of all companies in the SPY fund) issuing their earnings reports in that period.

According to FactSet , the estimated YoY earnings growth rate for S&P 500 companies is 4.1% in Q2 2022, which is the lowest rate since the fourth calendar quarter of 2020. Analysts also note that the number of companies which lowered their second-quarter guidance down to negative EPS levels is well above average.

As we can see, analysts and the companies themselves were not optimistic about these quarterly results. Such volatility in expectations may be related to the reassessment of the impact of global economic issues on the results of companies.

Key trends

Inflation

Inflation in the US accelerated to a record high since 1981, in May 2022 the main consumer price index ((CPI)) rose 8.6% that month. The most noticeable contribution to inflation was made by the renewed rise in prices for energy resources and food products after the April pause. Thus, over the past 12 months, energy resources have increased in price by 34.6% (+3.9% m/m in May), and food for the first time since the beginning of the observation has risen in price by more than 10% over the year. Inflationary pressure from energy prices is only growing so far - US gasoline prices have set a new record, exceeding $5 per gallon. Fuel rose in price in the second quarter following oil against the backdrop of a possible embargo announced by the EU on Russian oil.

Consumer inflation puts a lot of pressure on businesses. Many companies struggle to cope with increased costs and rapidly changing consumer sentiment. Thus, it puts massive pressure on margins and forces companies to revise their short-term outlook.

Supply chains

Labor shortages, COVID restrictions, geopolitical tensions, and other macroeconomic issues made the supply chain problems only worse in 2022. In the second quarter, we saw a massive energy prices hike due, which certainly had a bad effect on global supply chains.

The Global Supply Chain Pressure Index, which tracks the transportation costs data and manufacturing indicators, showed the pressure decrease in the last three months. However, the index is still at historically high levels.

Supply problems were chasing businesses in the second quarter. And there will be no sign of relief until the macroeconomic situation starts to improve. Companies are spending billions trying to improve their logistic networks, but it will only make a difference in the long run. The short-term outlook is full of uncertainty. 74% of S&P 500 companies cited "supply chains" on their earnings calls in the first quarter of 2022. That is the highest number since 2010.

The global economy slowing down

The military conflict in Ukraine, sanctions, and lockdowns in China have a stagflationary effect - they simultaneously depress economic activity and increase inflationary pressure. The basic scenario suggests that inflation will eventually peak this year and start to decline. However, recent economic data shows that there are signs of the inflation peak shifting to the end of the summer.

Due to the supply shock, inflation in developed economies is expected to be both unacceptably high at the end of the year and above the target levels of world central banks next year. At the same time, due to the threat of record inflation fixing at unacceptably high levels, the largest central banks are accelerating the normalization of monetary policy with a high probability of a transition from ultra-soft, not only to neutral, but also to restrictive policy, which should help cool demand. But central banks are unlikely to be able to quickly suppress inflation since not all of its factors are now determined by the monetary component as logistics problems, energy, and food shortages persist. As a result, weaker global economic growth is expected and recession risks are increasing, although the situation is not uniform across regions.

This earnings season is nothing more than an attempt to assess the macroeconomic situation based on the results and forecasts of the companies. Good corporate results and guidance will mark the business's confidence in these tough times and will result in a bounce in major indices.

The Tech factor

The Technology sector is expected to report the lowest earnings growth rate of 1.5% since the third quarter of 2019. In the first quarter, 27 companies issued negative EPS guidance, while 18 issued positive EPS guidance for the following quarter.

The sector is facing a great number of headwinds: slowing digital advertising sales, chip shortage, the decline in demand for such products and services due to a number of macroeconomic problems, and low growth earnings rates due to the 2021 high base effect.

For years tech companies, especially big corporations, like Microsoft (NASDAQ: MSFT ) and Apple (NASDAQ: AAPL ) were cash machines with huge profit growth. Investors thought that was a structural growth and now they are sitting in disbelief trying to figure out what went wrong.

Wall Street was witnessing lots of tech drama during the first-quarter earnings season. Software and services, hardware and equipment, and semiconductors stocks are all down since the quarterly results announcement with Netflix (NASDAQ: NFLX ), which saw a decade-long subscribers number growth and Meta Platforms (NASDAQ: META ), which reported a profit 21% decline, leading the fall.

The only silver lining in the cloud is, well, the cloud. Businesses seek to increase their efficiency as massive global digitalization continues. Precedence research expects the cloud market to reach $454 billion, up 17.3% YoY. This trend was the main revenue growth factor for Microsoft, Alphabet (NASDAQ: GOOG )(GOOGL), and Amazon (NASDAQ: AMZN ). The market will be looking for signs that demand has finally cooled off. If this happens, it will lead to panic among Big Tech investors, which could bring down the entire sector.

So why are tech earnings so important for the broader market? Well, foremost, because the Technology sector accounts for more than 24% of the entire SPY portfolio.

Then, it is all about valuation. Tech stocks' valuation has fallen sharply as the FED hawkish policy started to gain momentum, while the earnings kept steady. The performance of this sector largely reflects the current volatile market sentiment. Investors and the companies themselves gave a very conservative Q2 outlook as they work in a very uncertain environment. This earnings season will decide whether the market was right pricing a possible massive profits drop.

Conclusion

The corporate quarterly earnings reports will pretty much tell what is happening in the economy right now. Investors will be looking at earnings growth, management optimism, statements, overall outlook, and market reaction.

We did not receive enough information from the results of the first quarter as the companies simply pulled their guidance. Now, when things got a lot clearer, we can finally see full calendar year outlooks.

This earnings season is too big to be bad and in the current environment, any estimates are likely not worth the paper they are written on.

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