Q1 Earnings Likely To Disappoint, but It’s Not All Bad News

First-quarter earnings season started in earnest last week as major banks got the party started, but despite rising Treasury yields, bank earnings are proving to be, at best, a mixed bag.

That’s something to ponder because more than two-thirds of the S&P 500’s market capitalization steps into the earnings confessional by the end of April. As advisors know, macro risks ranging from commodities prices to inflation to rising interest rates and war are likely to be among the issues companies mention on upcoming earnings conference calls as drags on results.

Unfortunately, those macro scenarios aren’t abating anytime soon and that goes a long way toward explaining why the S&P 500 is lower by 8% year-to-date. It also explains why advisors will want to help clients keep level heads as earnings roll in over the coming weeks.

Macro Pressure, Positive Signs

As noted above, a variety of macro issues are pressuring risk assets this year, providing companies with easy excuses on which to blame slack results and it appears that’s exactly what’s on tap this earnings season.

“With a war, higher rates, and inflation creating elevated levels of macro uncertainty, analysts have been revising downward Q1 2022 figures. At the start of the year, projected growth for Q1 was 5.7%,” says State Street’s Matthew Bartolini. “Now, projected growth is 4.5%, the lowest year-over-year growth rate since Q4 2020.”

However, there are some possible bright spots and they arrive by way of downward earnings revisions that may ultimately prove too harsh.

“The downside analyst revisions also coincide with a higher-than-normal rate of firm negative guidance, as roughly 70% of the firms that have issued guidance for Q1 2022 have expressed negative views, below the typical 60% negative guidance view rate,” adds Bartolini. “In my view, this sets up a potential underpromise, overdeliver scenario, with firms projecting a lower bar that may be easier for them to surpass. And, on average, firms do beat the bar set by the market. Historically, 77% of firms report earnings above the average analyst estimate.”

In other words, it’s possible that S&P 500 earnings rise by double digits for the first three months of the year – a seemingly improbably notion given the rocky start to the year for equities.

More Reasons to Be Optimistic

As noted above, this is likely to be a trying earnings season, but it’s not a wholesale lost cause, either. In fact, smaller stocks could be pleasant surprises for clients.

“For instance, mid-cap stocks have witnessed a modest 10 basis point revision higher, with 15.31% growth now projected,” notes Bartolini. “Additionally, small caps have only witnessed a slight downside revision and are still projected to grow earnings by 13% in Q1.”

Among large caps ex-financials, cyclical sectors, not surprisingly with a boost from rising commodities prices, could be areas of strength this earnings season. Energy and materials are the sectors with the biggest revisions to full-year forecasts and that could be supportive of value strategies as 2022 moves along.

“Focusing on those markets with strong earnings sentiment (Energy, Materials, Small Caps) may be helpful as we enter an earnings season that will have some strength, even amid the weakened headline projections,” concludes Bartolini.

Sounds like good advice.

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