Second-Quarter Earnings Are Coming. What That Means for Stocks

Text size

Earnings season begins this coming week with big U.S. banks reporting. The

S&P 500
might not soar from the second-quarter reports, but some areas of the market might.

JPMorgan Chase

(ticker: JPM),

Wells Fargo

(WFC), and

Citigroup

(C) report on Friday. Earlier in the week,

Delta Air Lines

(DAL) and

PepsiCo

(PEP) will report their latest quarterly results. All will provide important clues to demand as the economy adjusts to the ongoing impact of higher interest rates.

The good news is that with Friday’s data showing a slowing job market, the Federal Reserve could soon stop hiking rates. Stocks ticked lower on Friday as investors digested the June employment report, and posted losses for the holiday-shortened week. The S&P 500 ended it down 1.2%, while the

Dow Jones Industrial Average
dropped 2% and the

Nasdaq Composite
slid 0.9%.

The S&P 500 is still up 23% from its low in October, however, and stocks are expensive. The index’s 12-month forward price/earnings multiple has climbed to 19.2 from 15 at the start of the rally, driven by hefty gains in some of the biggest technology stocks.

That’s a high P/E ratio, considering Friday’s 4.1% yield on a risk-free 10 year Treasury. The S&P 500’s earnings yield of 5.2%, based on forward 12-month results, is only about a percentage point higher, which isn’t much extra return, based on historic norms. Earnings would have to surpass expectations by a wide margin to justify current stock prices, and that isn’t likely to happen.

The capitalization-weighted S&P 500 is heavily influenced by the performance of Big Tech. If some of this year’s winners don’t dazzle investors with their quarterly numbers, that could spell bad news for the index. That’s why nontech stocks might be a better bet as earnings season starts to unfold.

The

Invesco S&P 500 Equal Weight
exchange-traded fund (RSP), which weights each stock in the index equally, has rallied by a more modest 16.6% from its fall low, and trades for about 15 times expected earnings, a 20% discount to the S&P 500, according to FactSet.

Bank stocks in particular look like a good bet. The

SPDR S&P Bank
ETF (KBE) is down 21% this year and trades for 7.7 times earnings, less than half the multiple of the Invesco fund. Industry earnings estimates are down 16% over the past six months, according to FactSet, reflecting analysts’ concerns about loan volumes and lower deal activity. Three U.S. banks failed this past spring, and that is also weighing on the stocks. But much of the pessimism is priced in, and good results from the nation’s biggest banks could give the sector a lift.

“We do think banks are going to get bid in the second half,” says Thomas Hayes, founder of Great Hill Capital.

Don’t expect earnings season to power the S&P 500 much higher, but look for opportunities in underperforming sectors.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com