What To Watch As Earnings Season Begins

While the S&P 500 closed at an all-time high on Friday, there are some concerning issues under the surface. Economic growth expectations seem to be laboring under concerns that the Federal Reserve could remove stimulus too quickly and smother growth. In addition, there are worries that the Covid variants could lead to another lockdown. While vaccinated people seem to have little risk of hospitalization or death from the variants, many countries still have relatively low vaccination levels, so global economic growth in the second half of the year could be negatively impacted. Value and small-cap stocks, which are more exposed to economic growth, were lower for the week. In addition, the yield on the U.S. 10-year Treasury fell to 1.36%, which does not reflect an expectation for robust growth.

With this challenging backdrop, the second-quarter earnings season likely takes on additional importance. The pace of S&P 500 year-over-year earnings and sales growth is almost sure to reach peak levels due to the easy comparisons with Covid-ravaged 2020 and robust economic growth in the quarter. The expectations going into the reporting season are eye-popping, with earnings slated to grow at over 63% year-over-year. If history is any guide, actual should still handily exceed these elevated levels. While it will be necessary for earnings and sales to beat expectations, forward guidance will be essential with the current worries about the economic outlook. In addition, the impact of supply chain disruptions and any color about the timing of normalization will be significant to forecasts. Lastly, the effect of higher costs and the ability to pass on higher prices to protect profit margins will be closely scrutinized.

While there are a handful of other big companies like Pepsi (PEP) and UnitedHealth (UNH) on the calendar, this week is all about the financials and the banks in particular. Among the banks reporting are JPMorgan Chase (JPM), Goldman Sachs (GS), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC), so the majority of big banks will provide financial results and an idea of the operating environment. According to FactSet, the financials are sure to be in the top of the earnings growth rates, with consensus year-over-year growth estimates of 116%.

Banks were stellar performers, gaining 80% for the year ending May 31, but are down 7% since that time while the S&P 500 is essentially flat. Banks have been significantly correlated with yields, so lower interest rates and concerns about the pace of economic growth have weighed on shares. Banks should show strong credit metrics and therefore reduce loan loss reserves which make exceeding the consensus earnings estimates highly likely. The more important things to watch in this case will be the second quarter’s actual and future outlook for loan growth, pre-provisioning net revenue (PPNR), and net interest margins (NIM). PPNR is a measure of sales from lending and fee income without the distortion from changes in loan loss reserves, which is a gauge of ongoing earnings power. NIM is the amount a bank is earning in interest on loans compared to the amount it is paying in interest on deposits, which could be pressured by low rates. While many banks already announced dividend increases following the recent Federal Reserve stress test results, additional share buyback plans should be revealed.

Aside from earnings, the U.S. economic calendar is packed with important releases. June consumer inflation (CPI) on Tuesday could remove some concerns about runaway inflation if some transitory inflation begins to fade and May CPI proves to be the peak year-over-year inflation rate. Retail sales for June on Friday will give a read on consumer spending and should show a positive reading for the portion that impacts GDP after two straight down months in the wake of the stimulus-enhanced reading for March.

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