Inside Q2 S&P 500 Earnings

At Q2’s close, most analysts expected earnings and sales to fall, with many presuming this posed a reality check for stocks. But with nearly all S&P 500 companies reporting, a couple things seem worth noting: First, just a few sectors are responsible for the S&P 500’s year-over-year earnings decline. Second, revenues bucked expectations and continued rising overall. This doesn’t say anything about Q3 or beyond, but in our view, it shows reality is better than most anticipated.

With 460 S&P 500 companies reporting through today, blended Q2 earnings (combining actual results and remaining estimates) fell -5.0% y/y, while blended sales rose 0.7%—both above quarter-end expectations of -7.0% and -0.4%, respectively.^[i] Although a majority of companies typically top earnings estimates, Q2’s 80% beating expectations so far exceeds the 1-, 5- and 10-year averages.

As Exhibit 1 shows, even as earnings declined the last few quarters, sales didn’t, a prominent feature of this cycle. The three sequential year-over-year earnings drops through Q2 have many calling this stretch an “earnings recession.” Some are comparing this to the five-quarter earnings recession that ended in Q2 2016, which—like this one—didn’t come with a broader economic recession (as of yet). That earnings downturn then was Energy-driven, too (more on this later). Though stocks never entered into a bear market then, they did experience rough sledding from mid-2015 to early-2016. Notably, they troughed in February 2016 before earnings did in Q4, anticipating a profit rebound. We see stocks’ October trough this time similarly.

Exhibit 1: Earnings Dipped, but Sales at All-Time Highs

Source: FactSet, as of 8/11/2023.

Bolstering this optimism, in our view: Sales never stalled like they did in 2015 – 2016. Typically during recessions, revenues drop as this more directly reflects economic activity than profits, which can reflect everything from inflation to cost cuts to tax changes and more. This doesn’t tell you much about the future, but it can help explain why stocks moved on quickly from earlier recession fear.

Reality also seems better than headline results imply, as the Energy and Materials sectors skew Q2 earnings lower. These two sectors’ profits shrank by around a half and a third, respectively. (Exhibit 2) But this isn’t surprising with commodity prices down big from last year, as Energy and Materials firms’ profits tend to be more price-sensitive than production-volume sensitive. For Energy, as FactSet noted: “Lower year-over-year oil prices are contributing to the year-over-year decrease in earnings for this sector, as the average price of oil in Q2 2023 ($73.56) was 32% below the average price for oil in Q2 2022 ($108.52).”^[ii] Energy’s earnings decline detracted -6.7 percentage points and Materials’ -1.2. Excluding Energy and Materials, Q2 earnings rose 2.9% y/y—not particularly great, but far better than what surface-level coverage we see suggests.

Exhibit 2: Energy and Materials Skewing Earnings Lower

Source: FactSet, as of 8/11/2023.

Now, almost halfway through Q3, all this is rather backward looking for stocks, which are pricing in earnings conditions over the next 3 to 30 months. On that front, analysts are penciling in a recovery with earnings growth expected to accelerate in the second half and into next year. We think the current bull market reflects an improving outlook. In our view, last year’s bear market pre-priced the current string of negative earning quarters, but since last fall, stocks have been looking forward to better times ahead.