Will this results season be a catalyst for cyclical stocks?

Few expect much good news from the upcoming second-quarter reporting season, but some believe this will be the trough in corporate earnings.

The earnings foundations of Wall Street’s recent buoyant run are about to be revealed as JPMorgan Chase & Co (NYSE:JPM) and Citigroup Inc (NYSE:C) prepare to begin the Q2 reporting season.

While the S&P 500 index jumped more than 7% over the three month period, this outperformance was led by a handful of mega-cap stocks on excitement over the application of generative AI for products, services and business processes.

The combined market value of the top 10 companies in the S&P 500 now accounts for 31.7% of the index, but JP Morgan Asset Management noted recently that their earnings contribution has been declining and now stands at only 21.5%.

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However, there have been signs of earnings momentum going into the reporting season, after FactSet reported that the tech sector accounted for the highest number of companies issuing positive earnings per share guidance for the second quarter at 20.

Overall, the financial data company said the second quarter’s 46 companies issuing positive updates was the highest for a three month period since autumn 2021.

The highest profile upgrade in recent weeks has been by NVIDIA Corp (NASDAQ:NVDA), which designs Graphics Processing Units used in the gaming, mobile and automotive industries as well as in enterprise data centres. It is now worth over $1 trillion after it raised its outlook far above Wall Street expectations, helping shares up more than 190% this year.

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On the other side, FactSet reports that 67 companies have issued negative earnings guidance for the second quarter, and that seven sectors are expected to report lower earnings than forecast at the start of the period.

The overall earnings decline for the S&P 500 is estimated to be 7.2%, which if achieved would mark the largest fall since the height of Covid disruption, as companies grapple with the impact of higher interest rates and stubborn price pressures. It will also mark the third straight quarter in which the index has reported a year-over-year decrease.

Bank of America believes the reporting season may represent a trough quarter for US earnings at 5% lower year-on-year, meaning a potential catalyst for cyclical stocks.

The bank said: “March-April was likely the trough in business conditions, followed by a better May, an even better June, and continued momentum into July. This sets up well for a 2H recovery and a cyclical rally, where positioning in cyclicals has never been this low.”

It sees three potential tailwinds driving earnings growth in the second half, including stimulus from the Infrastructure Investment and Jobs Act and the Inflation Reduction Act. The other factors are softer year-on-year comparatives and favourable currency movements.

And despite the banking scare in March, the US economy has so far proved to be much more resilient than many analysts had expected.

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Higher interest rates by the Federal Reserve mean the financial sector is expected to report the highest year-over-year revenue growth rate of all eleven sectors at 7.6%. FactSet said this will be strongest in the consumer finance and banking industries with growth of 14%.

JP Morgan, which is due to report figures on Friday, is forecast to post growth of 28% and lift net income by more than 40% despite a slowdown in dealmaking activity.

The bank is regarded as a bellwether for the US economy, meaning the comments of chief executive Jamie Dimon on the outlook for loan loss provisions and consumer confidence will be as important as the figures themselves.