Second quarter results: equities may survive reporting season relatively unscathed

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Recession, pah. Investors seem to perceive a “no-cession” ahead. Equity indices in the US and Europe this year are all up. Indeed, some fear equities may be ripe for a pullback. These markets should survive the second-quarter reporting season without taking a tumble.

It is easy to see why one might nervously await the current crop of results. The S&P 500 and the Euro Stoxx 600 have both risen by about a quarter since the start of October. While economies have so far proved relatively resilient to interest rate rises, soft landings are a historical rarity. Meanwhile, the Chinese economy sputters, which detracts from global growth. 

This stock market rally, though, is not as fragile as some fear. It is neither based on unreasonable near-term earnings expectations, nor on toppy valuations. The exception to that is the US tech sector, currently in the grip of an AI-driven frenzy. 

Take a look at earnings, first. Analysts have modelled falling margins for the second quarter of the year, assuming that when growth slows companies cannot pass on cost inflation as easily to customers. Consensus corporate earnings should fall 13.3 per cent in Europe, and 8.5 per cent in the US compared with last year, according to Barclays. 

While some sectors — energy included — are having a difficult time, those declines hardly look like high bars to clear. And full-year expectations for flattish earnings look sensible, in the context of expected GDP growth of about 1 per cent. 

Valuations do not look outlandish either, especially in Europe. The market puts forward earnings at around 12 times, a discount of almost 10 per cent to the region’s 15-year historical average. The US looks frothier, at 18.5 times earnings.

All this may help investors avoid disappointment in the near term. The catch is that analysts’ expectations for 2024 are a lot more upbeat. That may be simple arithmetic, with analysts anticipating an earnings rebound after this year’s declines.

So any good earnings news this year may just steal from next year. Expect next year’s earnings estimates to moderate in the months ahead, as companies provide longer-term guidance.