Beware: S&P 500 Outperforms Q2 Earnings Expectations, Yet Caution Looms

**Wall Street Surprised as Corporate Earnings Beat Expectations**

Wall Street’s Pessimism and the Earnings Beat

Wall Street analysts were pessimistic about corporate earnings this year due to rising interest rates and stubborn inflation that weighed on American industry. They predicted that S&P 500 companies’ earnings per share (EPS) would drop between 6% and 7% year-over-year in the second quarter. However, with 87% of the firms in the blue chip index reporting earnings, it turns out they managed to beat Wall Street’s low EPS targets by an average of 2%, according to Bank of America. This performance puts them on pace for a more modest decline of 4% to 5% in EPS.

Companies Overcoming Expectations

While there are still big-name firms like Disney, Walmart, and Nvidia yet to report their results, 70% of the 423 companies that have reported earnings through last Friday managed to beat Wall Street’s EPS forecasts. Additionally, 60% of these companies surpassed sales estimates. This strong performance has led Savita Subramanian, head of U.S. equity and quantitative strategy at BofA, to describe it as a “solid beat and raise quarter.” Interestingly, investors have offered muted reactions to these resilient earnings, with even companies that forecasted rising earnings seeing their stocks fall 0.05% on average the day after reporting, compared to the historical average rise of 1.93%.

Reasons Behind the Earnings Beat

Dylan Kremer, Certuity’s co-chief investment officer, believes that the S&P 500’s earnings momentum in relation to analysts’ forecasts is not surprising. He explains that corporate America guided for a steep drop in their earnings this quarter, which left them room to outperform. However, despite beating Wall Street’s consensus forecasts, the expected aggregate earnings decline for the second quarter, which includes actual and estimated results, remains at -5%. Overall, though, the second quarter earnings season has been strong, indicating that large U.S. companies have been able to navigate the challenging economic environment thus far.

Optimism and Increased Corporate Sentiment

U.S. executives are feeling more optimistic recently due to fading inflation and steady job growth. BofA’s Subramanian mentions that her three-month guidance ratio, which measures the ratio of companies that offer above- vs. below-consensus earnings guidance, has jumped to 1.3x. This is the highest level since 2021 and significantly ahead of the historical average of 0.8x. BofA’s analysis of earnings transcripts also shows that sentiment improved in the second quarter, rising 5 percentage points year over year, which is the biggest jump since the third quarter of 2021.

Wealth Managers Remain Cautious

Despite stronger-than-anticipated second-quarter earnings, a hot labor market, and increasingly bullish executives, wealth managers remain concerned about the stock market. The S&P 500’s significant increase of nearly 18% to date, coupled with aggregate earnings on pace to decline 5%, raises concerns among wealth managers like Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. She questions how much more can go right, as economic strength suggests that interest rates will be higher for longer, making rich multiples unsustainable. Shalett recommends her clients trim their exposure to the most richly valued U.S. stocks in light of this year’s run-up in share prices. Another wealth manager, Ryan Belanger, founder and managing principal at Claro Advisors, advises investors to remain vigilant and not become complacent, as the market’s inflation and Federal Reserve fears remain intact. He believes it is too early to add new money to work at current valuations.

In Conclusion

While corporate earnings have beaten expectations so far this year, wealth managers are apprehensive about the stock market due to concerns about rising interest rates, inflation, and future economic conditions. The resilience of earnings in the face of challenges has been notable, but caution remains as investors evaluate the sustainability of the current market rally and the potential risks ahead.