Results from Q1 2023 earnings season are arguably carrying extra weight for investors, as many try to gauge how higher interest rates and bank stress may have combined to impact profits in the first three months. As I write, it’s still too early in the reporting season to draw sweeping conclusions. But I do think it’s fair to say that any narratives about an ‘earnings cliff’ can be safely set aside. It’s just not happening.1
As my colleague and the Director of Research at Zacks, Sheraz Mian, put it: “The picture emerging at this early stage is one of resilience and stability, with an above-average proportion of companies beating estimates and providing a good-enough outlook in an uncertain macro environment.”2
Indeed, 77% of the approximately 90 reporting S&P 500 companies have beaten earnings expectations, which marks a higher beat percentage for these specific companies than in each of the previous three quarters. One question that’s emerging about this earnings season is whether analysts were too pessimistic in lowering earnings expectations, or whether corporations are delivering stronger-than-expected results in a better-than-expected macro environment.
I think both are true.
On the analyst side, there hasn’t been adequate appreciation for the idea that the earnings recession likely started about a year ago, which I think implies that we’re nearing the bottom or already past it. Energy sector earnings have distorted the overall picture in the last year, with high commodity prices resulting in a profit surge that skewed results for the broad S&P 500. But when we strip away the energy sector’s contributions, we find that S&P 500 earnings have been contracting on an annual basis since Q2 2022. In short, forward estimates today don’t seem to be considering the possibility of an earnings recovery in the second half of the year.
Banks have also been a key driver in this quarter’s better-than-expected results (to date), but not in the way most investors expected in the wake of regional banking stress. The worst fears of a financial contagion did not come to fruition, and major banks have performed far better than anticipated. As a result, Q1 earnings for Financials are now expected to be up +7.6% from the year-earlier period, a significant improvement from the +0.3% growth expected just one week ago.
The three most prominent players in the space – JPMorgan, Bank of America, and Citigroup –handily beat top- and bottom-line estimates. JPMorgan’s Q1 earnings, for instance, were up an impressive +52.4% from the same period last year on +24.8% higher revenues on record net-interest income. Earnings estimates for the June quarter have been increasing for these major banks as well, which I think investors should read as a significant positive surprise. Remember, just one month ago many were questioning the health and stability of the banking sector.
A final observation I’d make about this earnings season is that operating margins appear to have turned the corner for the positive. The past year has posed many challenges for corporate profits, largely from rising labor costs and some companies’ limited ability to pass on rising input costs to consumers. Those pressures appear to be easing now, and there’s a good argument that margin pressures may have peaked in Q4 2022 (see chart below). This metric is critical, as operating margins are an important gauge of profitability and also a leading indicator for stocks.
Zacks Investment Research3
Bottom Line for Investors
As I mentioned at the outset of this column, it’s still early in Q1 2023’s earning season, so there will be plenty more insights and takeaways to parse. I’ll likely revisit the earnings story once all the results are in.
But our early read is that earnings overall are shaping up to be far better-than-expected this quarter. In my view, analysts got too cautious in anticipating the fallout from bank stress, which to date has not materialized into much of an economic impact. But there have also been persistent expectations for a recession—which has yet to arrive—baked into estimates. When looking out at estimates for future quarters, the key question becomes: what happens if the U.S. avoids recession altogether?
1 Bloomberg. April 22, 2023. https://www.bloomberg.com/news/articles/2023-04-22/better-than-feared-earnings-has-analysts-rethinking-projections#xj4y7vzkg
2 Zacks.com. April 24, 2023. https://www.zacks.com/commentary/2083630/big-tech-earnings-looming-what-to-expect
3 Zacks.com. April 24, 2023. https://www.zacks.com/commentary/2083630/big-tech-earnings-looming-what-to-expect
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