Q2 Earnings Season Preview: Bank of America Strategists Predict Market Shifts Amid Economic Uncertainty
In a detailed note to clients this Tuesday, Bank of America strategists have set the stage for the upcoming Q2 earnings season, following a robust Q1 performance. As investors prepare, the insights provided by BofA could be crucial for navigating the anticipated market dynamics.
Strong Q1 Sets High Expectations
In Q1, Corporate America outperformed, with earnings per share (EPS) exceeding consensus estimates by 3%. This success came amidst a relatively simpler year-over-year comparison, with a 6% decline in Q2 2023 compared to a 3% decline in Q1 2023. For Q2, BofA strategists are forecasting a 2% beat, aligning with historical averages and marking the smallest beat since Q4 2022.
Macroeconomic Challenges
Despite a positive start, macroeconomic conditions have deteriorated since Q1. The Economic Surprise Index (ESI) has plummeted to its lowest point since June 2015, indicating a potential 3% miss in Q2 earnings. However, historical trends provide a glimmer of hope: since the global financial crisis, EPS have beaten expectations 91% of the time when the ESI was negative, averaging a 3% beat. “An EPS miss is rare,” BofA strategists emphasized.
Analysts' Confidence
BofA's Q2 preview suggests that, despite weaker economic indicators, analysts have held steady on their earnings estimates since March. This is noteworthy as estimates typically drop by 4% on average leading into earnings season, highlighting analysts' confidence in their forecasts.
Key Growth Dynamics
A critical factor this earnings season is the anticipated shift in growth dynamics. Q2 is poised to be the first quarter of EPS growth for the "Other 493" companies in the S&P 500, excluding the Magnificent 7, since Q4 2022. Conversely, growth for the Magnificent 7 is expected to decelerate for the second consecutive quarter, continuing into Q3. “Growth is broadening out and so should the market,” BofA strategists remarked.
Demand vs. Inflation
While demand is the primary driver of earnings, inflation remains a lagging indicator. Fortunately, the anticipated demand recovery in the latter half of the year isn't overly optimistic. Excluding the Magnificent 7, consensus projects just a 1% real sales growth in the second half. This modest expectation is bolstered by the end of the de-stocking cycle, one of the sharpest in history. Improved ratios of new orders to inventories suggest the inventory correction phase is nearing its conclusion.
AI Investments and Future Prospects
The upcoming earnings season is also expected to shed light on AI investment impacts. Although monetization of AI may take longer than anticipated, major tech companies are continuing their aggressive investments. Consensus predicts a 34% increase in capital expenditure (capex) from hyperscalers in 2024, totaling approximately $200 billion. The key question remains whether these companies will sustain their investment levels even if monetization is delayed. BofA strategists believe we are in the early stages of an AI investment cycle, with no signs of slowing down.
Breaking It Down: What Does This Mean for You?
This article provides a comprehensive overview of the upcoming Q2 earnings season, highlighting crucial trends and economic indicators. Here’s a simple breakdown:
- Strong Q1 Performance: Corporate America did well in Q1, beating earnings expectations by 3%.
- Economic Challenges Ahead: Macroeconomic conditions have worsened, suggesting a potential earnings miss in Q2.
- Analysts' Confidence: Despite economic challenges, analysts are confident in their earnings forecasts.
- Growth Shifts: Smaller companies in the S&P 500 (excluding the top 7) are expected to show growth, while the top 7 may see slower growth.
- Demand vs. Inflation: Demand is expected to recover modestly in the second half of the year, with inflation being less of a concern.
- AI Investments: Major tech companies are heavily investing in AI, which could impact future earnings.
Understanding these factors can help you make informed decisions about your investments, as the dynamics of the market evolve in response to earnings reports and economic conditions.