Transcript
Amada Agati:
School’s back in session, which means in this month’s Adding Alpha, it’s time to hit the books and study earnings to help us gauge how the rest of the year might play out.
With Q2 earnings season for the S&P 500 in the books, what a quarter it was! With a whopping 11.9% year-over-year growth rate for the quarter, it might seem hard to remember the estimate going into earnings season was not even 5%. That makes upside surprise an impressive 7.7% - one of the strongest quarters of the cycle.
That sure sounds like an A+ report card, but it might be more like a B+ if we don’t grade on a curve, because we’re seeing some evidence of market concentration creeping back in. Ex-Mag 7, the earnings growth rate drops ~380bps to 8.1%.
It’s still a solid number and the upside surprise is still well above the 5-year average of 450bps.
Good enough to keep the market rally engaged at a fairly rich 22x forward P/E, but considering the S&P 500 was only up about 4% from the start of earnings season through the end of August, what it tells us is simply some of the good news was already priced in following the V-shaped recovery in late spring.
Even though there still seems to be a great divide between the Mag 7 and the bottom 493, Q2 earnings season demonstrated one important fact: the AI innovation cycle is still growing, and we got the last of that confirmation with $NVDA’s strong results last week.
However, not everyone got a passing grade on their Q2 earnings report card. Energy sector earnings were down nearly 20% and the Materials sector was the only sector with an overall earnings miss by about 1% below consensus estimates. It’s not so much a signal that manufacturing activity is fundamentally weakening, despite recent ISM/PMI survey data back in contraction would suggest, as the Industrials sector itself saw top-line growth estimates get revised higher for Q3. Instead, it’s more a reflection of supply chain cost pressures and inefficiencies weighing on profit margins of manufacturers and lackluster crude oil prices impacting the Energy sector due to over-supplied production dynamics.
Despite some of these “not at all new” challenges and a “stickier than anyone would like” inflation backdrop, neither appear to be materially impacting profit margins; the S&P 500 posted a Q2 margin of 13.7%, marking the best quarter since 2022 and just 25bps off the all-time high! It’s a challenging environment to be sure, but companies are still finding ways to drive positive operating leverage.
As the calendar shifts to September and seasonality starts to creep in, volatility could pick up. At the surface, things look A++ with positive Q3 revisions for the overall S&P 500, but it’s largely being driven by…you guessed it, the Mag 7. Ex-Mag 7, the 7.5% projected growth for Q3 falls ~600bps.
The decline is largely being driven by the Healthcare sector (down a whopping 700bps sequentially) which continues to be under significant cost and regulatory pressures. But most sectors also saw revisions move lower from Consumer Staples to Industrials (down anywhere from 200 to 400bps sequentially). We’re still talking positive growth, but some sectors that rallied through the summer may have to repeat a grade, or in this case, maybe just an earnings quarter….
If we zoom out, 2025 earnings growth looks like it’s shaping up to be a strong 10.6% and 2026 is projected to accelerate to 13.4%. Could that be the elusive mid-cycle reacceleration I’ve been dreaming of all year long?!
Between here and there, it’s September. And, there’s still a ton of “Earth” to cover, at least a couple of Fed rate cuts to create a tail-“Wind”, and enough purple haze of lingering policy uncertainty to start a “Fire”. Wake me up when September ends. Until then, class dismissed!!
