Significant Q3 Earnings Downgrades

Investing.com reports that third-quarter earnings downgrades have significantly affected major regions, particularly in the U.S. and Eurozone, as highlighted by JPMorgan strategists. This reflects increasing concerns regarding slowing topline growth and macroeconomic uncertainty.

In a note published Monday, the Wall Street firm detailed that the earnings outlook for S&P 500 companies has been sharply reduced. They pointed out that "the hurdle rate has come down for Q3, suggesting the bar for surprises is lower."

Despite this lowered hurdle, the overall expectation for year-over-year EPS growth in Q3 has been revised downward from 8% a few months ago to just 4%. Notably, the EPS forecast for companies outside the Magnificent 7 (the largest tech firms) was at a mere 1.4%, a significant drop from the previous quarter’s 5% growth rate.

According to the note, “The differential between Mag-7 and the rest of S&P 500 earnings growth is likely to continue narrowing.” Historically, the Magnificent 7 have been significant contributors to S&P 500 earnings, but their growth is now slowing. JPMorgan forecasts the group's earnings to grow 17% year-over-year in Q3, which is half of Q2’s performance and a third of anticipated Q4 2023 growth.

Looking at sector performances, downgrades are primarily focused in cyclical sectors such as Commodities, Industrials, and Consumer discretionary. In contrast, Financials remains the only sector in the green among Cyclicals, while defensive sectors like Utilities and Real Estate are “holding up better,” according to JPMorgan strategists.

Regionally, European earnings have experienced even more pronounced cuts compared to the U.S. For the Eurozone, Q3 EPS growth projections have shifted from a 4% growth expectation to a 2% contraction. Key drivers of this poor performance include the energy and automotive sectors.

In the U.S., there is minimal divergence in growth between cyclical and defensive sectors, with both hovering around 0-4%. The report expresses worries about future earnings, noting that global PMI data is declining, suggesting continued topline deceleration and potential for more earnings downgrades.

JPMorgan highlights that Brent crude oil prices, a major global pricing benchmark, are generally “strongly positively correlated with sales growth” and are indicating potential downturns.

Despite profit margins at index level being above historical averages in both the U.S. and Europe, they could deteriorate if sector mix worsens. Moreover, over 40 U.S. and European firms have already issued profit warnings ahead of the earnings season, with European stocks reacting severely—an average drop of 10% on announcement days.

Overall, JPMorgan warns that although expectations have been lowered, there is no assurance that results will incite a positive market response. With 2024 EPS projections nearing a year-low in both regions, their note states, “EPS revisions really need to turn up in order to support P/E multiples.”

They add, “The P/E vs EPS correlation was historically clearly positive, and the gap is opening up.” Strategists advise a cautious outlook on sectors including Chemicals, Luxury, Industrials, Autos, Semiconductors, and Mining, emphasizing weak earnings revisions and a potentially soft Q3 reporting season. They suggest that the recent rebound in cyclicals might lose momentum and recommend considering cyclical investments only post-Q4 earnings season.