Turbulent summer cannot hide the US stock market's Q2 earnings exceeding expectations. Profit growth remains robust this earnings season

According to Zhitong Finance APP, the U.S. stock market has experienced a tough summer, casting a shadow over the most popular earnings season for American companies in years. Despite significant sell-offs in companies like Tesla (TSLA.US) and Amazon (AMZN.US), on the day of earnings announcements, the S&P 500 index components with profits exceeding expectations reacted with a median outperformance of 1.7% compared to the benchmark index, marking the largest gap for Bloomberg Intelligence since 2019. The underperforming components fell behind the index by only 1.1%, one of the narrowest gaps during the same period.

Therefore, as an informal prelude to this earnings season, despite the S&P 500 index falling by over 7% since JPMorgan announced earnings on July 12, the market has also rewarded individual companies delivering on their promises.

This trend is also a response to the strongest profit growth of U.S. companies in the past three years (in absolute terms). Although S&P 500 index components faced higher expectations leading up to the earnings season, they still performed better than expected overall, with a 13% profit growth in the second quarter. BI data shows that this is the largest increase since the fourth quarter of 2021, which will help alleviate concerns about softening consumer demand and weakening pricing power due to cooling inflation.

"Nothing to Complain About"

Gina Martin Adams, Chief Equity Strategist at BI, said: "There's nothing to complain about in terms of earnings for S&P 500 index components companies." In a report titled "Stop Blaming Earnings for the S&P's Woes," she wrote: "Although revenue misses are more frequent than usual, the current guidance trend is positive."

Previously, analysts believed that the company delivered "outstanding" performance amid the fast-food industry "collapse," making it one of the most notable risers this earnings season, followed by a surge of 8.4% in DoorDash (DASH.US). Barbie doll maker Mattel (MAT.US) soared 10% on July 24 due to its impressive profit margin, while Bank of New York Mellon (BK.US) hit an all-time high on July 12 after releasing better-than-expected quarterly results.

However, the S&P 500 index does not seem to have reaped significant rewards from this strong quarter. Instead, the market is concerned about overvaluation of high-tech companies driven by the artificial intelligence boom, as well as worries about the Federal Reserve's slow pace of interest rate cuts and its inability to avoid an economic downturn.

With the proportion of companies exceeding sales expectations at its lowest level since 2019, Wall Street professionals are curious about how long profit margins can be sustained. Companies with disappointing profit margins or expectations have seen their stock prices take a hit: Tesla fell by 12% on July 24 after lower-than-expected profit margins, while Super Micro Computer (SMCI.US) and Airbnb (ABNB.US) dropped by 20% and 13% respectively on Wednesday after disappointing earnings announcements However, in most cases, investors are more tolerant of stocks that fall below expectations than usual. For example, when GE HealthCare Technologies (GEHC.US) lowered its expectations, analysts said that this was largely in line with expectations, and as a result, the stock price rose by 2.4%; after Kraft Heinz (KHC.US) significantly lowered its annual organic sales target, the stock price rose by 4.1% because the company is not expected to experience a larger decline, which relieved investors.

Resilient Prospects

Despite widespread concerns about the impact of economic contraction, Scott Chronert, a strategist at Citigroup, said that he has not changed his earnings expectations for this year.

Chronert said, "We are still satisfied with the profit estimates for the S&P 500 index components, but we also acknowledge that there may be some risks if a traditional recession occurs." He added that the team's model shows that profit growth in 2024 is "highly likely" to reach around 10%, and it will further increase next year.

According to data compiled by BI, analysts currently expect earnings to grow by 8.5% and 14.2% in 2024 and 2025, respectively.

Meanwhile, data from JP Morgan shows that the positive trend in US corporate earnings this quarter has not translated to Europe. Stocks in the STOXX 600 index in Europe with lower-than-expected profits underperformed the benchmark index by 2.2%, the largest gap since at least 2016. On the other hand, stocks with earnings better than expected only outperformed the benchmark index by 1.6%.

Chris Hart, portfolio manager at Boston Partners, said, "US investors are highly optimistic, while European investors tend to be relatively pessimistic. However, US stock valuations are much higher, and from a medium-term perspective, the pendulum may swing back to Europe when there is a very attractive valuation opportunity."