The U.S. stock market witnessed an amazing rally in the first half of 2023, surpassing expectations and sparking optimism among investors. However, as the second-quarter earnings season begins, a growing chorus of Wall Street strategists, including Michael Wilson from Morgan Stanley (as quoted on Yahoo Finance), cautions about a changing investing backdrop. Ripe equity valuations and high interest rates coupled with diminishing liquidity are threats to the continuity of the rally.
Company Forecasts Will Likely Hog Limelight
Usually, earnings reports play a significant role in shaping market sentiment and driving stock prices. Every investor looks for stocks that can beat market expectations and be able to raise earnings. However, Wilson argues that this time around, company forecasts will overshadow actual earnings results. Given the prevailing edgy market conditions, investors will pay more heed to the forward-looking guidance in Q2.
Earnings Landscape Shifts From “Better Than Feared” to Heightened Uncertainty
The stock market’s rally in the first half of the year was aided by better-than-feared earnings and expectations of peaking interest rates. However, recent profit downgrades and increasing concerns over a choppy outlook have weighed on market sentiment. The S&P 500 experienced a decline in July due to rising rates. This shift highlights the need for a cautious approach amid mounting uncertainty.
Profit Warnings in the Cards?
According to Bloomberg’s Markets Live Pulse survey, market participants are preparing for profit warnings and anticipate higher interest rates to have a significant impact on the S&P 500 during this earnings season. The reports from major U.S. banks, which kick off the season this week, will be under high focus. There is potential for a year-over-year decline of 9.7% in second-quarter earnings — a significant drop since 2020, per Zacks Earnings Trends issued on Jul 5, 2023.
Any Silver Lining Ahead?
On the positive side, 2023 Q2 earnings estimates have increased for four sectors since the quarter began. These sectors are Construction, Tech, Transportation, and Industrial Products, Zacks Earnings Trends. It shows that these sectors hold more optimism.
Though Goldman Sachs Group emphasized being cautious about overly optimistic analysts’ expectations of a pickup in profits in 2024 (per the Bloomberg article), the brokerage house believes that the Q2 earnings season will come out as healthy.
Sector ETFs in Focus
Industrial Products – Industrial Select Sector SPDR ETF (XLI) – Zacks #2 (Buy)
Earnings are expected to rise 4.7% in Q2 over a 5.3% uptick in revenues. The underlying Industrial Select Sector Index includes companies from the following industries: industrial conglomerates; aerospace & defense; machinery; air freight & logistics; road & rail; commercial services & supplies; electrical equipment; construction & engineering; building products; airlines; and trading companies & distributors. The fund charges 10 bps in fees.
Construction – Invesco Dynamic Building & Construction ETF (PKB) – Zacks #2
Earnings are expected to decline 24.4% in Q2 over a 0.5% decline in revenues. The underlying Dynamic Building & Construction Intellidex Index comprises stocks of U.S. building and construction companies. The index is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including fundamental growth, stock valuation, investment timeliness and risk factors. The fund charges 57 bps in fees.
Technology – Technology Select Sector SPDR ETF (XLK) – Zacks #1 (Strong Buy)
Earnings are expected to decline 5% in Q2 over a 0.1% decline in revenues. The underlying Technology Select Sector Index includes companies from the following industries: computers & peripherals; software; diversified telecommunication services; communications equipment; semiconductor & semiconductor equipment; Internet software & services; IT services; wireless telecommunication services; electronic equipment & instruments; and office electronics. The fund charges 10 bps in fees.
Transportation – SPDR S&P Transportation ETF (XTN) – Zacks #2
Earnings are expected to decline 1.9% in Q2 over a 4.0% decline in revenues. The underlying S&P Transportation Select Industry Index represents the transportation segment of the S&P Total Market Index. The fund charges 35 bps in fees.
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Technology Select Sector SPDR ETF (XLK): ETF Research Reports
Industrial Select Sector SPDR ETF (XLI): ETF Research Reports
Invesco Dynamic Building & Construction ETF (PKB): ETF Research Reports
SPDR S&P Transportation ETF (XTN): ETF Research Reports
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