The US second quarter earnings season is almost upon us, with Alcoa — keeping with tradition — kicking off proceedings after the closing bell on Monday (Tuesday 6am AEST).
After the S&P500 rallied 7% from post-Brexit lows, extending the gains since mid-February to 17.7%, many are now pondering whether earnings season will provide the impetus to drive the index to fresh all-time highs, or simply result in a fresh bout of profit-taking from investors.
After such an enormous rally, coming despite expectations for a fourth consecutive quarterly year-on-year decline in earnings per share (EPS), it’s understandable why some investors — not all — are cautious.
While it believes that second quarter earnings are likely to top expectations — falling only 2% compared to the median market forecast for a decline of 4.7% — Bank of America-Merrill Lynch’s (BAML) equity and quant strategy team are of the view that an expected recovery in earnings is now all but priced in by investors.
They explain (our emphasis in bold):
Earnings season for 2Q is about to kick off, and despite our expectation of a 3% beat vs.consensus, we think S&P 500 EPS is still likely to come in below 2Q15. While this would mark the fourth consecutive quarter of negative y/y EPS growth, in our view, what is encouraging is that 1Q likely marked the trough. Despite the negative impact of the Brexit vote, we see EPS growth accelerating throughout the rest of the year, but not nearly at the trajectory of consensus expectations, which imply growth will accelerate from -6% in 1Q to +9% by 4Q and +16% by 1Q17. And given the S&P 500’s 15% rally since mid-February, we are concerned that much of the improvement in earnings growth may already be priced in, especially with signs that earnings revision trends may be rolling over.
In other words markets have already factored in an improvement in earnings in coming quarters, suggesting that there may be some downside risks to US markets should earnings underwhelm lofty expectations.
The chart below, supplied by BAML, looks at expectations for EPS growth over the next 18 months, comparing its view to the market’s. BAML certainly expects EPS to grow far slower than what the broader markets is anticipating at present.
Following the release of Alcoa’s earnings report on Monday, financial heavyweights JP Morgan Chase, Citibank, Wells Fargo and Blackrock, along with Yum! Brands, will report results later in the week.
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