Bank of America Predicts Q2 Earnings Season: What Investors Should Expect
In an insightful note to clients on Tuesday, Bank of America (BofA) strategists offered a comprehensive preview of the upcoming Q2 earnings season. Following a robust Q1, investors are keenly awaiting the next round of corporate results.
Q1 Recap: Strong Performance Amid Lowered Expectations
Corporate America managed to surpass expectations in Q1, with earnings per share (EPS) beating consensus estimates by 3%. This performance was facilitated by an easier year-over-year comparison, as Q2 2023 saw a 6% decline compared to a 3% decline in Q1 2023.
Anticipating Q2: Modest Beat Expected
BofA strategists project a 2% beat for Q2, which aligns with the historical average but marks the smallest beat since Q4 2022. Despite a strong start to the year, macroeconomic conditions have deteriorated. The Economic Surprise Index (ESI) has hit its lowest point since June 2015, indicating a potential 3% miss in Q2 earnings. However, historical data suggests some optimism: post-global financial crisis, EPS have beaten expectations 91% of the time when the ESI was negative, averaging a 3% beat.
Analyst Confidence and Market Dynamics
Unlike the usual trend where earnings estimates are cut by 4% on average into earnings season, analysts have maintained their forecasts since March. This deviation suggests strong confidence in their projections. BofA's earnings revision ratio and guidance ratio both improved in Q2, signaling that growth is holding steady. However, foreign exchange was a 100bp headwind to sales, the largest impact since Q1 2023.
Growth Dynamics: A Shift on the Horizon
One key trend to watch this earnings season is the expected shift in growth dynamics. Q2 is anticipated to be the first quarter of EPS growth for the "Other 493" companies, excluding the Magnificent 7, since Q4 2022. Conversely, growth for the Magnificent 7 is expected to slow for the second consecutive quarter and continue decelerating into Q3. BofA strategists believe this broadening of growth could positively impact the market.
Demand vs. Inflation: A Balanced Outlook
While demand remains the primary driver of earnings, inflation is a lagging indicator. The anticipated recovery in demand for the second half of the year is not overly optimistic, with consensus expecting just a 1% real sales growth, excluding the Magnificent 7. This modest expectation is supported by the end of a sharp de-stocking cycle, as indicated by improved new orders to inventories ratios.
AI Investments: A Long-Term Play
Lastly, the earnings season will likely shed light on the impact of AI investments. Major tech companies continue to invest aggressively in AI, with consensus forecasting a 34% increase in capital expenditure from hyperscalers in 2024, totaling around $200 billion. While monetization may take longer than hoped, there are no signs of slowing investments, and BofA believes we are in the early stages of an AI investment cycle.
Breaking It Down: How This Affects You
- Strong Q1 Performance: Corporate America's strong Q1 indicates resilience, which could be positive for stock prices and investor confidence.
- Modest Q2 Expectations: A predicted 2% beat in Q2 suggests moderate growth, but macroeconomic challenges could pose risks.
- Analyst Confidence: Analysts maintaining their earnings estimates signals stability and potential for growth.
- Growth Dynamics: The shift in growth dynamics, particularly the broadening beyond the Magnificent 7, could lead to a more balanced market.
- Demand vs. Inflation: A balanced outlook on demand and inflation could mean steady economic growth without runaway inflation.
- AI Investments: Continued investment in AI by major tech companies suggests long-term growth potential, though immediate returns may not be significant.
In essence, the upcoming Q2 earnings season is expected to be a mixed bag of modest growth, continued investment in AI, and shifting market dynamics. Staying informed and understanding these trends can help you make better financial decisions and potentially capitalize on market opportunities.