US Q2 earnings: Strong beat on soft expectations
The US Q2 earnings season is off to a solid start. After 35% of earnings reports, 71% of companies managed to beat pre-season consensus expectations, which would be the highest beat rate since Q2 2022 and well above the 50% beat rate in Q1. The strong beat count also translates into earnings coming in well ahead of expectations. The S&P 500 has now reported EPS that beat consensus estimates by 4% above the levels consensus had expected, the strongest earnings surprise since Q2 2022.
If the remainder of the reports before the end of the season are in line with expectations, the S&P 500 will report EPS growth of -7% yoy and -1% qoq. However, if companies manage to beat expectations until the end of the season to the same extent they have so far, qoq earnings growth would turn positive at 3% and the yoy decline in EPS would fall to -3%. This would mark Q1 as the trough in the earnings cycle, when qoq growth came in flat and yoy EPS declined by -4%.
Consumer discretionary has so far seen the strongest EPS increase among sectors this season, driven by a rebound in travel and leisure earnings, with airlines being a key driver. However, other discretionary subsectors have not fared as well. For example, auto EPS fell 5% yoy, but that could still change in the coming weeks, given that various major manufacturers have yet to report.
The financial sector, which dominated the first few days of the season, also performed well. Not only did it benefit from another solid increase in net interest income in Q2, but it also saw other sources of income recover from the Q1 slump. While the financial sector's headline EPS growth came in at -5% qoq (+6% yoy), this does not reflect the underlying strength. However, once Goldman Sachs is excluded from the sector aggregate, the qoq number jumps to +2% and yoy growth to +12%.
Tech earnings have also been strong compared to expectations, with more than 90% of companies beating consensus numbers so far. Yet, given the elevated valuations, the bar for these numbers to translate into results was quite high, leaving the sector’s performance trailing the market since the start of the season. The key takeaways from the earnings reports are that (i) AI revenues are likely to be spread over the next few quarters rather than materialising immediately, while (ii) tech-related communication services companies show that advertising revenues have rebounded in Q2 and (iii) cost-cutting continues, helping the bottom-line in the tech space. Some of the largest names in the sector have yet to report. We expect the current picture to stay the same: small disappointments are likely to suffer more than beats are being rewarded.
While there’s been no reversal of the downtrend in consensus earnings so far, we expect the season to provide some positive impetus for EPS revisions in the coming weeks. However, given that valuations are already substantially more stretched than at any point over the past year, market upside is set to materialise only very gradually, if at all. We prefer pockets of the market that have trailed the recent rebound, such as value and small caps.
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