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S&P 500 would be in an ‘earnings recession’ if not for this one booming sector — but that may not last long

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Fears of an actual recession are weighing on investors near the end of 2022, but there is another type of recession also in sight: an earnings recession.

The S&P 500 index would already be in an earnings recession if it were not for one high-flying sector in 2022: energy. Higher oil prices have led to huge profit for energy companies so far this year. FactSet forecasts a 118% jump in third-quarter profit as earnings begin to roll in, in line with huge gains through the first half of the year.

Overall, FactSet forecasts third-quarter earnings-per-share growth for the entire S&P 500 to come in at 2.4% when compared to the year-earlier period. Delta Air Lines Inc.
DAL,
-4.02%

and big banks like JPMorgan Chase & Co.
JPM,
-2.00%

kick off earnings season for the quarter in the week ahead, as Wall Street zeroes in on whether businesses can pivot amid higher prices, a stronger dollar, lopsided supplies and signs of weaker demand.

Excluding the energy sector, the earnings estimate for the third quarter would drop to a 4% decline. During the second quarter, earnings declined 4% when factoring out energy’s gains.

Put the two quarters together, and you have an ex-energy earnings recession, or at least two quarters of bottom-line declines. If you included the energy sector but excluded any other individual sector, the overall S&P 500 earnings growth rates for both quarters would remain positive, said John Butters, senior earnings analyst at FactSet.

Yet even as the weather cools down, Russia’s war in Ukraine drags on and OPEC and allies plan production cuts, the energy sector’s contributions to earnings growth are likely to fade soon as it runs up against tougher year-over-year comparisons.

“Q4 is the last quarter where energy is expected to be really a main driver of earnings growth,” Butters said in an interview. “Then going forward, really after the first quarter of 2023, it’s expected to be a drag on earnings instead of a positive contributor.” 

The S&P 500 index
SPX,
-2.80%

suffered an earnings recession through all of 2019, after profits for many companies soared in 2018 due to federal tax cuts. With earnings still growing off 2021’s record rates, forecasts appear to suggest another earnings recession is coming in 2023.

The all-inclusive estimate for 2.4% earnings growth would be the worst showing since third quarter of 2020, when pandemic lockdowns still blanketed much of the economy. Those estimates have also come down considerably since the summer. Three months ago, estimates for third quarter called for 9.8% year-over-year growth, Butters said. The gap between those estimates is wider than average, and some strategists don’t think they’ve come down enough.  

Still, Butters noted, historically, more than 70% of S&P 500 companies beat earnings estimates each quarter, even though the magnitude of those beats has been below average this year. But he said if recent trends bear out, actual earnings growth for the third quarter could reach around 6%.

As for sales, they’re expected to grow 8.5% across S&P 500 companies for the third quarter when compared to the third quarter of 2021. Margins were expected to be 12.2%, continuing to hold close to the high levels earlier this year, but slightly off some of the records hit last year. However, both figures have been propped up by higher prices, even as higher wages cut into margins.

Other analysts, meanwhile, have wondered whether recent results from athletic-gear giant Nike Inc.
NKE,
-3.34%

and chipmaker Micron Technology Inc.
MU,
-2.93%

— which, respectively, were marred by aggressive discounting plans to slim down inventories and an abrupt drop-off in demand — offered foreshadowing for the results to come. And as recession concerns multiply, they wonder whether companies have maxed out whatever gains they can squeeze out of customers by charging more.

“The question now is, ‘Is pricing power out of the system?’” said Nancy Tengler, chief executive at Laffer Tengler Investments. “Are companies going to be able to continue raising prices?”

This week in earnings

For the week ahead, 15 S&P 500 companies, including three from the Dow Jones Industrial Average, are set to report quarterly results, according to a report from FactSet on Friday.

Along with Delta and JPMorgan Chase, one of those Dow components, two others — health-insurer UnitedHealth Group Inc.
UNH,
-2.75%

and Walgreens Boots Alliance Inc.
WBA,
-5.36%

— also report. PepsiCo. Inc.
PEP,
-0.73%

also report during the week.

The call to put on your calendar: JPMorgan Chase

JPMorgan Chase reports third-quarter earnings on Oct. 14, with the conference call to follow. The bank is considered by many to be an economic bellwether. But with the economy in flux, investors will likely turn to CEO Jamie Dimon for his read on consumer spending and demand for loans, as prices and borrowing costs rise, markets tumble and central banks globally try to wrestle down inflation.

Dimon, during recent questioning on Capitol Hill with other bank executives, indicated that banks had showed some resilience against the current backdrop.

During a conference last month, Daniel Pinto, JPMorgan’s chief operating officer, noted the possibility of “a couple of quarters of a shallow recession” if the Federal Reserve’s rate-hike trajectory isn’t enough to tackle inflation. But for now, he said spending and the labor market remained “robust,” despite inflation, the war in Ukraine and other geopolitical tensions, and moves by the Fed to take the guardrails off the economy following a massive infusion of pandemic-related aid. And he noted easing, though still elevated, energy prices and less pressure on the supply chain — two big reasons for higher prices over the past year.

“So essentially, it’s quite OK, overall,” he said then.

The number to watch: Bank profits, forecasts

Analysts polled by FactSet expect JPMorgan to earn $2.92 per share for the quarter, down from the year-ago quarter. But revenue of $32.1 billion would be up over that time.

However, even as banks try to navigate slowing trends in investment banking and weaker demand for car and home financing amid higher interest rates, Wall Street analysts’ earnings outlooks have largely held up.

Even if higher rates from the Fed make borrowing more expensive for consumers, those rates allow banks to charge more for things like credit cards and auto loans, boosting their net-interest margins.

“People don’t understand, there is still loan demand out there,” Dave Wagner, portfolio manager and analyst at Aptus Capital Advisors, told MarketWatch in a separate bank earnings preview. “Banks can still benefit from higher average yields and excess liquidity put back to work.”

Citi analyst Keith Horowitz on Tuesday said JPMorgan had been “more disciplined than others on being patient to deploy cash,” and expected the bank to bump up its outlook for net interest income, or the profit generated from loaning out money at a higher interest rate than what a bank pays out to depositors. He said bank stocks overall remained “oversold due to credit concerns.”

Elsewhere, Citigroup Inc.
C,
-2.02%

also reports on Friday, with results potentially offering clues on the state of the financial sector internationally. Wells Fargo & Co.
WFC,
-1.07%

and Morgan Stanley
MS,
-2.93%

report that day as well.

Delta earnings also due

Delta Air Lines reports third-quarter earnings on Thursday. Analysts polled by FactSet expect the airline to earn $1.55 per share, on revenue of $12.9 billion. The results will offer a window into whether the travel industry’s rebound has any momentum left as prices rise.

William Walsh, director-general of the International Air Transport Association, told CNBC last month that airfare prices could increase. However, Delta President Glen Hauenstein, during a conference last month, remained optimistic on travel demand.

“We’re expecting a very, very robust demand for the holiday periods, both Thanksgiving and Christmas,” he said. “And it looks to us now as though business is going to have a very strong fall which is always great for October.”

Analysts love these stocks as the fourth quarter gets underway, including this luxury car maker

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