Q2 Earnings: An Early Analysis
7min read As the Q2 earnings season unfolds, we are beginning to examine the early returns to understand their impact on market dynamics. Despite the initial flurry of results, the market has experienced a downward trend, prompting us to investigate the extent to which these earnings reports are influencing broader market movements. With key companies starting to release their financials, the next few weeks will be crucial in determining whether these earnings can stabilize or further unsettle the current market trends. Early Indications Historically, a high percentage of companies tend to beat earnings estimates, a trend that is expected to continue in Q2. Since 2000, approximately 70% of companies have regularly beaten estimates by 5%. This beat rate has increased to around 75% since 2017, largely due to the consistent downward revision of analysts' estimates as the reporting period approaches. The Q2 2024 earnings season for the S&P 500 is off to a solid start on paper, but only 40% of companies have reported so far. Notably, 82% of these companies have beaten their EPS (earnings per share) estimates, reflecting an 8% year-over-year growth in EPS. While the number of company's beating is impressive, the overall gain of 8% falls slightly short of the 9% consensus number for the quarter. The Magnificent Seven are expected to generate most of these gains and we have only seen two (GOOG, TSLA) reports. Also, companies tend to beat by an average of 3% on a historical basis. So, while the number of companies beating is higher, the quality of the beat is falling short of expectations. This could be due to the lack of reductions in earnings consensus numbers heading into the season. As we stated in the Q2 earnings preview, this was a higher bar than companies are used to beating. Typically, consensus quarterly EPS estimates are reduced by 7% during the six months prior to the start of the reporting season. However, for Q2 2024, the consensus EPS estimate has been cut by just 1%, indicating an unusually resilient outlook. Excluding the mega-cap tech firms, analysts have trimmed EPS estimates by 3%. This embedded optimism suggested that the average EPS beat of 8% during the past four quarters will be challenging to replicate in the upcoming reporting season. In fact, for the rest of the year, earnings are projected to increase by 15% from Q1 through Q4. This is well above the historical average of 10% and the Median 8%. Recall in our Q2 earnings preview we wrote: "The heightened sense of expectations means that companies delivering only slight beats might struggle to generate significant positive momentum in their stock prices. Investors, accustomed to substantial outperformance, may find modest earnings surprises underwhelming, leading to potential profit-taking. This dynamic could particularly impact sectors with previously inflated valuations, as even minor disappointments or lackluster guidance could prompt swift corrections. Therefore, the combination of high expectations and conservative corporate outlooks may create a precarious environment for equities, where even positive results could fail to sustain rallies". This aspect is playing out in the early part of earnings. Growth Concerns As far as the top line expectations goes, only 45% of the companies have surpassed sales expectations, despite a 9% year-over-year increase in sales. These mixed results suggest that while earnings performance is solid, revenue growth is not as widespread, indicating potential variability in market demand and pricing strategies across different sectors. It also raises the concern around growth as the Fed continues to keep rates at restrictive levels. The 45% rate of top line beats is extremely low on a historical basis. This obviously raises growth concerns as evidenced in rate cut expectations as CME Fed Fund Futures now price in a 100% chance of a rate cut. Expectations for a 50-basis point rate cut are up to 10% compared to 4% last week. The weaker revenue numbers and decline in economic data is raising the question about a policy miss step with the Fed staying restrictive for too long of a period. Former Federal Reserve Governor William Dudley penned an opinion piece for Bloomberg highlighting the need for a rat cut. He was initially a proponent of higher for longer interest rates to control inflation, the author now believes the Federal Reserve should cut rates, ideally at the upcoming policy meeting. Despite previous economic resilience due to pandemic-era cash, government investments, and a surging stock market, recent data indicates the Fed's tightening measures are taking effect, with slowed growth, increased unemployment risks, and abating inflation. However, the Fed's hesitation to cut rates stems from concerns over past inflation misjudgments, a desire for consensus, and a dismissal of rising unemployment signals, which historically precede recessions. Cutting rates soon is deemed crucial to prevent a self-reinforcing economic downturn. If we continue to see earnings underperform expectations in the coming sessions, then the importance for the Fed to strike a dovish tone at next week's Fed meeting will grow. This will be an important factor for trading next week but we would expect earnings to remain the overriding driver into early August. The market did receive some good news today in the form of the Advanced Q2 GDP which came in at +2.8% on a sequential basis, better than the +2.0% growth economists projected. This news helped facilitate the intraday bounce. The PCE component also came in higher than expected which may throw some cold water on a potentially dovish Fed. We believe that markets are more concerned about a decline in the economy than a Fed rate cut. Thus, this news is viewed as a positive and outweighs "hopes" of a Fed rate cut. This underscores the importance of the Q2 earnings season as we will see the "boots on the ground" commentary from corporations. Some Notable Reports and Price Reaction: Alphabet (GOOG) The first of the Magnificent Seven (along with Tesla) to post Q2 results. Overall, the numbers were good. The miss on YouTube revenue raises some red flags as it points to a slow down in ad spending that has rippled through the tech sector. The beat on cloud was encouraging. The biggest issue for GOOGL though was the rise in expenses which highlights the cost associated as companies scramble to support AI advancements. GOOG shares fell 5% in the following session, breaking below support at the 50-day moving average. Shares are trading at seven week lows and nearing oversold conditions with an RSI of 37. Tesla (TSLA) Tesla (TSLA) shares rallied aggressively ahead of its earnings. A combination of a short squeeze, hype around robotaxi, and political tailwinds helped propel shares from $179 at the end of June to $270 in early July. The stock started to see some profit taking ahead of the report. The Q2 results disappointed as the company missed on the key margin ex-credit line. It also failed to provide guidance on delivery expectations for 2024 which has lead analysts to downgrade expectations. The stock was hammered, falling 11%. This has weighed on the Consumer Discretionary ETF (XLY) as it and Amazon (AMZN) make up approximately 43% of the holdings. The stock is searching for support but a slide toward the 200-sma ($205) looks likely. Lamb Weston (LW) Lamb Weston (LW) is not a household name although it is likely in your household. The consumer discretionary play has jumped onto radars as it tumbled 28% following its earnings release. The company engages in the production, distribution, and marketing of value-added frozen potato products or as most of us know it, french fries. The company missed quarterly estimates and issued below-consensus earnings guidance sending the stock to a two-year low. Perhaps the most important aspect of the LW report, at least in terms of its impact on the markets, is that McDonalds (MCD) is its largest customer. MCD is of course a prominent member of the Dow Jones. So, the LW results have reverberated through the market and put further pressure on consumer discretionary spend as investors question restaurants Q2 performance. Seagate Technologies (STX) Seagate posted one of the better quarters with a 29 cent beat on the bottom line. STX outpaced revenue expectations by a slim margin. However, the provided one of the better outlooks as it guided both EPS and Revenue above consensus expectations. The news highlighted the strong demand for storage chips which should bode well for both Micron (MU) and Western Digital (WDC). However, the stock reaction in the group was relatively muted. STX did end the day up 4% which is notable given the Nasdaq had its worst day since December 2022. The problem was that the stock was unable to hold gains. Both WDC and MU would end the day lower. We would watch STX closely. One can understand a poor earnings report leading to some selling pressure. If STX is unable to hold gains, that would be even more telling about the sentiment around technology stocks. International Business Machines (IBM) IBM reported strong Q2 earnings, surpassing analyst expectations with adjusted EPS of $2.43 against an estimate of $2.20, and revenues of $15.8 billion versus an expected $15.616 billion. The company's gross margin was 56.8%, exceeding the forecasted 56.1%. IBM maintained its guidance for mid-single-digit revenue growth for FY24 and raised its free cash flow guidance to over $12 billion, which was initially projected at around $12 billion. AI was a key driver for results so the story does remain alive and well. These were strong results and the outlook is another positive. The stock jumped from $184 to $194 in reaction. But, similar to STX, it is showing some inability to hold these gains. This would be a troubling trend for the tech industry. The Banks This will focus on the major money centers (JPM, BAC, WFC, C, MS, GS). The results were generally positive. The top and bottom line beats were mixed but the underlying fundamentals were steady. Loan growth was down from the prior quarters but it did not suggest a rapid slow down in economic growth. The banks remained conservative with provisions and reserve builds but credit remained benign in the data. The primary takeaway from this group is that the economy remains in a good place and credit issues are not set to pressure financial conditions. The SPDR Trust Financial ETF (XLF) rallied during the releases, hitting $44.10 before sliding back 3% with the broader market sell off. The ETF is coming in to key support around the $41-42 area which houses the 20- and 50-day moving average. Airlines The slowdown in consumer spending has been evidenced in the commentary from the airlines. Delta (DAL) kicked off the season with an unconventional cautious outlook. This raised red flags for the sector as the feeling was, if DAL is having issues, what does that mean for the rest of the group? The answer came this morning when American Airlines (AAL) and Southwest (LUV) posted poor quarters and provided a cautious outlook as consumers are spending less on travel. The airlines are also taking a hit from the Crowdstrike (CRWD) outage which delayed thousands of flights over the weekend. The U.S. Global Jets ETF (JETS) fell below its 200-day moving average ($18.99) in early trade but we are seeing a bounce with the broader market. The ETF is down 10% since mid-May which suggests some of these cautionary comments had been priced into the airline stocks. We highlighted the concern around a decline in tech names who posted strong results. Well the exact opposite approach can be taken around the airlines if we see them shake off cautious comments and rally higher. Next week's jobs report will be critical for a follow through on any potential bounce.
