Where are the opportunities amid the U.S. earnings season?

Market Update

This week investors continue to ponder softer inflation numbers, and what they may mean for the economy and markets. On Wednesday the UK also saw a surprise decline in its consumer inflation, leading the 2-year Gilt back below 5%. Sovereign yields across developed markets edged lower throughout the week. The 10-year U.S. Treasury yield is now back at around 3.75%, after an aggressive move higher over the last month. Equity markets continued to grind higher with the start of the earnings season, with the focus moving to regional banks and technology companies in the coming days. To many, the optimism looks premature, as arguably the end-cycle debate is far from settled. But the market has decided to keep its ‘soft-landing’ hopes – so this may well be the path of least resistance until the facts change.

Meanwhile in Greater China, the mood is decidedly more somber. China released a slew of activity data for June and Q2 GDP numbers, which overall paints a very mixed picture. The post-COVID recovery is ongoing, but in the absence of major policy stimulus it is advancing at a slow pace given that the economy is also dealing with a range of other issues – most notably the aftermath of a property slump. In response, analysts are lowering their GDP forecasts for China, again. Evergrande, the poster-child of the boom and bust property sector in China, released its much delayed 2022 financial results, revealing steep losses and elevated debt. The macro and sentiment downturn dragged the CSI300 Index lower over the week, while the Hang Seng Index treaded water. The RMB continued to hover around 7.2, torn between a weaker USD and a slow recovery in China.

In this week’s Asia Strategy Weekly, we turn our focus to the U.S. equity market. Amidst generally positive market sentiment, the Q2 earnings season has kicked off. With an unexpectedly strong market rally this year, the bar is clearly high for stocks that have performed well. As the reporting season ramps up in earnest, this week’s note examines what to expect and how to position for opportunities.

Strategy Question: Where are the opportunities amid the U.S. earnings season?

With 1Q23 U.S. earnings growth meaningfully better than expected at just -2% YoY, consensus is expecting a sequential deterioration with 2Q23 earnings to decline -7.5% YoY. However, this is largely due to two sectors: energy and materials – where weaker commodity prices are leading to deeply negative sector earnings growth of -48.9% and -31.7% YoY respectively. Excluding these two sectors, 2Q23 earnings in the U.S. are expected to be flat, which is a sequential improvement over 1Q23. In fact, seven out of eleven sectors are expected to see positive earnings growth this quarter. With recent company commentary at conferences, we believe these expectations are beatable. That being said, the S&P 500 is up ~17% year-to-date, and the bar is clearly higher for stocks that have had very strong performance this year. We will be paying attention to management commentary regarding margins – looking for signs of improvement or new pressures to help gauge potential further market upside. Our expectations are for other cyclical sectors that have lagged the rally to catch up throughout and after the earnings season. The equally-weighted S&P 500 is one way to implement this broadening of the rally in U.S. equities, in our view.

Over the last few months investors have clearly been anticipating a softer landing than what was presented in December, and we’ve seen valuations back to 19x forward estimates. We expect management teams to provide more optimistic commentary than earlier in the year as the labor market has cooled, financial conditions have not tightened considerably, and recession risks appear delayed. Market breadth could come into play and the median stock’s earnings outperformance could translate into better performance in non-mega cap, mid, and small-cap companies. Overall, we believe that it is quite plausible for 2Q23 earnings to be revised up by 2% (vs current expectations) by the end of the reporting season.

A concept we have been intrigued with is the ‘rolling earnings recession’, which is somewhat unique due to the circumstances surrounding the Covid-19 pandemic. We have noticed that sectors within the S&P 500 have had their own mini earnings cycles over the past three years. To some extent, this has led to strong sector earnings contributors being offset by segments undergoing headwinds. One simple dynamic that highlights this phenomenon is the travel and hospitality sector, which saw challenging trading conditions in 2020/2021, while electronic goods and appliances witnessed particularly strong demand. These conditions then flipped in 2022 as social distancing measures ended in most Western developed economies. Over the past twelve months, the Consumer and Communications sectors had their turn facing negative earnings pressure that subsequently led to cost containment and inventory reduction actions, which in turn provides for a recovery in earnings growth in the current context. On the other hand, Energy and Materials are likely to witness significant declines in growth, with negative revisions in 2H23 given the slowing economy and some pockets of excess supply.

Earnings seasons have historically been positive for equities. Many sectors are exiting a correction phase and investors will likely increasingly favor early cycle segments as economic growth slows but soft landing odds improve.

The Private Bank’s Equity Strategy team believes that the Q2 reporting season will likely help market strength broaden, both by sector and capitalization. Equal-weighted S&P 500 and the mid-cap S&P 400 could participate and outperform – valuations outside the mega cap space are below average and could allow for some short-term catch-up, and there are attractive structures for investors to participate in this opportunity. We also see a number of single stock opportunities that we are positive on as we head into earnings results. Please contact your JP Morgan advisor for more details on our top equity ideas.

All market and economic data as of July 20, 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

There can be no assurance that any or all of these professionals will remain with the firm or that past performance or success of any such professional serves as an indicator of the portfolio’s success.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

This document may also have been made available in a different language, at the recipient’s request, and for convenience only. Notwithstanding the provision of a convenience copy, the recipient re-confirms that he/she/they are fully conversant and has full comprehension of the English language. In the event of any inconsistency between such English language original and the translation, including without limitation in relation to the construction, meaning or interpretation thereof, the English language original shall prevail.

This information is provided for informational purposes only. We believe the information contained in this video to be reliable; however we do not represent or warrant its accuracy, reliability or completeness, or accept any liability for any loss or damage arising out of the use of any information in this video. The views expressed herein are those of the speakers and may differ from those of other J.P. Morgan employees, and are subject to change without notice. Nothing in this video is intended to constitute a representation that any product or strategy is suitable for you. Nothing in this document shall be regarded as an offer, solicitation, recommendation or advice (whether financial, accounting, legal, tax or other) given by J.P. Morgan and/or its officers or employees to you. You should consult your independent professional advisors concerning accounting, legal or tax matters. Contact your J.P. Morgan team for additional information and guidance concerning your personal investment goals.

Indices are not investment products and may not be considered for investment.

For illustrative purposes only. This does not reflect the performance of any specific investment scenario and does not take into account various other factors which may impact actual performance.

These are presented for illustrative purposes only. Your actual portfolio will be constructed based upon investments for which you are eligible and based upon your personal investment requirements and circumstances. Consult your J.P. Morgan representative regarding the minimum asset size necessary to fully implement these allocations. 

Past performance is not a guarantee of future results.  It is not possible to invest directly in an index.

RISK CONSIDERATIONS 

• Past performance is not indicative of future results. You may not invest directly in an index. 
• The prices and rates of return are indicative as they may vary over time based on market conditions. 
• Additional risk considerations exist for all strategies. 
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service. 
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

Index Definitions

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight - or 0.2% of the index total at each quarterly rebalance.

The S&P MidCap 400 provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, is designed to measure the performance of 400 mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

The Hang Seng Index ("HSI"), the most widely quoted gauge of the Hong Kong stock market, includes the largest and most liquid stocks listed on the Main Board of the Stock Exchange of Hong Kong.

The CSI 300 Index is a free float adjusted, category-weighted index which measures the performance of A-Shares traded on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. The Index consists of the 300 stocks with the largest market capitalisation and good liquidity from the entire universe of listed A-Shares companies in the PRC mainland.