US earnings season: Q3 preview

With a bit of puff taken out of stock markets in recent sessions, we look ahead to the flood of results from America’s biggest companies due out over the next few weeks.

A results season that's been billed as a “make-or-break” quarter kicks off tomorrow with expectations rising on Wall Street for downgrades to 2022 earnings guidance.

The results for the September quarter are likely to be decent, with US financial data group FactSet estimating an earnings growth rate of 27.6% for S&P 500 companies.

This would be the third highest year-over-year growth rate reported by the index since 2010 and follows a bumper second quarter, when S&P 500 firms topped consensus by 17%.

But the summer now looks to have been the high water mark for Wall Street profitability after Q3 saw the emergence of some significant headwinds, such as supply chain issues, the Delta-driven slowdown, and most recently the spike in natural gas prices.

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The inflationary pressures, in particular, have triggered a bout of erratic trading for global markets in recent weeks as investors speculate that the Federal Reserve and other central banks will be forced into an earlier-than-expected tightening of monetary policy.

The Fed is likely to begin tapering its $120 billion (£88 billion) stimulus support as early as next month and the Bank of England may make a modest rise in interest rates as soon as December.

Borrowing costs will remain at ultra-low levels, but for most of the 600 market respondents in a recent Deutsche Bank survey it is inflation rather than Covid-19 that is now their biggest worry.

In fact, 71% expect at least another 5% off equities at some point before the year is out. There is also a fairly strong consensus that stagflation of some kind is more likely than not, especially in the UK where over 50% expect it over the next 12 months.

Bank of America is concerned that Wall Street is still being too optimistic in thinking that inflation pressures will soon pass. The squeeze on profitability is likely to be evidenced in the third-quarter results, but the current Wall Street consensus is for the margin position to flatline in the fourth quarter before an expansion in 2022 to new record highs above 2018 peaks.

The bank's analysts warn this means guidance could turn “ugly” during what they describe as a make-or-break results season: “We expect current headwinds to last well into 2022, and see risk to consensus numbers.

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“Analysts have consistently underestimated margins over the past five quarters, but given the worsened macro environment for corporate profits, we do not expect those big margin beats to repeat in 3Q.”

Higher oil prices have historically been positive for earnings in the S&P 500, but Bank of America warns it could be a headwind this time if soaring gas prices add pressure to chemicals and utilities stocks and there's a revenues hit for beneficiaries of energy sector expenditure.

The third-quarter earnings season starts tomorrow with JPMorgan Chase (NYSE:JPM) and continues with the other big banks over the rest of the week. The action picks up pace next Tuesday when Procter & Gamble (NYSE:PG) and Netflix (NASDAQ:NFLX) posts figures, the day before numbers from Tesla (NASDAQ:TSLA) and IBM (NYSE:IBM).

Bank of America added: “Based on leading indicators, tech, real estate and energy screen well ahead of results, while sectors that are hurt by rising energy prices, utilities and the consumer sectors (also hurt by wage inflation), screen poorly.”