April 23, 2024
Investors

Five Themes for Investors to Watch as Earnings Season Kicks Off


(Bloomberg) — After the big fourth-quarter rally in US stocks, investors are about to find out what companies have to show for it in their earnings scorecards.

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Not much is baked into expectations, so there’s room for an upside surprise: Analysts project that S&P 500 Index members will see fourth-quarter profits grow 1.1% on average from a year earlier, which would be the smallest positive figure since before the pandemic, data compiled by Bloomberg Intelligence show. The equities benchmark surged 11% last quarter, the best performance since 2020.

Friday kicked off the announcement cycle, with JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. reporting. Next week brings a broader array of companies, including smaller lenders and aluminum producer Alcoa Corp.

Here’s a look at five key themes to watch as more scorecards roll in over the next few weeks.

Leaving Profit Contraction Behind

The third-quarter reporting season halted a three-quarter streak of contracting S&P 500 profits, but analysts need definitive signs the slump is in the rearview mirror. There’s no guarantee that’s the case, especially with the slim margin of growth that BI data indicate. What’s more, when excluding the seven tech titans, the S&P 500’s profits will likely shrink.

The rather bleak outlook for this reporting cycle contrasts with the 11% profit expansion that BI data indicate for all of 2024. So Wall Street will have its eyes peeled on guidance to see whether companies expect to deliver that kind of momentum.

“We’re gradually emerging from earnings recession, and in that sense, fourth-quarter results will set the tone for 2024,” said Quincy Krosby, chief global strategist at LPL Financial. “Guidance is extremely important during this transition from a high-inflation period to a period where inflation is easing but not yet to where policymakers need it to be.”

All About Margins

Profit margins — a measure of how much profit companies are squeezing from their sales — will be at the center of Wall Street’s attention. After three quarters of improvement, net income margins are expected to drop to about 11.7%, the lowest since 2020, data compiled by BI show.

The dip reflects the challenge that some firms face in passing along input costs to consumers as wage pressures remain sticky in several low-productivity industries that are difficult to automate. Profit margins are going to be the lowest in health-care and consumer staples stocks, BI data show.

The good news is that they are soon expected to pick up. The median gross margin is expected to be about 8 basis points higher in the next 12 months relative to the prior 12 months, data compiled by Trivariate Research show.

That dynamic means “gross margins are likely to expand for many companies if current macro conditions persist,” wrote Adam Parker, founder of Trivariate.

Not Just AI

Analysts expect artificial intelligence will raise global gross domestic product by $7 trillion in the next 10 years, according to Cresset Capital LLC. But analysts want to see what it means for profits now.

The seven-largest stocks in the S&P 500 — from Apple Inc. to Meta Platforms Inc. — will likely see their profits grow 46% in the fourth quarter, while the remainder of the index will likely see a 7.1% slump, according to BI.

Later in the year, the gap will likely start to narrow. The S&P 500 index, leaving out the Magnificent Seven, is expected to return to growth with first-quarter earnings and gain momentum as the year progresses, clocking a 19% profit expansion in the fourth quarter — above that of the Magnificent Seven.

“It’s not just AI,” said Marshall Front, chief investment officer at Front Barnett Associates. “We want to know how the American consumer is doing — and banks have a very good handle on that. We want to see the latest trends in cyclical sectors like energy, real estate and health care.”

Macro Forces

While investors will keep their focus on top- and bottom-line figures, they’ll pay equal attention to what companies are saying about topics that are beyond their control.

Corporate executives’ outlook for forces like geopolitics and politics is deteriorating, even as their views on company fundamentals keep improving. The latter now exceeds the former by the most in at least 20 years, calculations compiled by 22V Research show.

At 22V Research, Dennis Debusschere said he will focus “on margins and if CEOs sound better about the world.” If they do, he said, “you can presume improving capex.”

Diverging Views

The consensus call for anemic profit growth in the fourth quarter masks widely differing outlooks for the various S&P 500 sectors. Two of the 11 segments — utilities and communication services — are expected to post profit expansion above 40%, while three — energy, health care and materials — will likely see a profit contraction of 20% or more.

That’s partly the reason a gauge of expected one-month correlation in S&P 500 stocks has tumbled to around 0.14 – a level seen only a handful of times in the past 10 years, data compiled by Bloomberg show. A reading of 1 means securities move in lockstep.

“At this point of the economic cycle, as some of the biggest macro issues start to subside, we expect to see a wider divergence between winners and losers,” said Chris Zaccarelli, chief investment officer of Independent Advisor Alliance. “It’s not going to be ‘a rising tide lifts all boats’.”

–With assistance from Jessica Menton and Alexandra Semenova.

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