Stock investors had hoped that the latest earnings report would help sustain the market rally, but it looks more likely that it will halt the gains.
The S&P 500 is up 32% from its 52-week low in October. Driving the rally are market expectations that companies will continue to grow sales and profits at a healthy pace. Economic growth in the second quarter beat expectations and inflation appears to have calmed enough for the Federal Reserve to cut interest rates once this year, which would lead to an extension of the economic expansion.
But the sales and profit picture may not be so rosy.
Analysts expect S&P 500 sales and profits to generally increase in the second half of the year compared to the first half, according to FactSet. Analysts typically cut their quarterly forecasts in the second half of the year, with September seeing the most frequent forecast cuts, according to Trivariate Research. The key for investors is to get ahead of these adjustments and apply second-half forecasts to today’s context.
Consumer spending, which accounts for a large portion of the U.S. gross domestic product, appears to be starting to slow as rising prices and interest rates are encouraging consumers to save more and spend less.
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McDonald’s second-quarter earnings, released on Monday, are an example of how other companies could be affected. The company’s quarterly sales fell short of expectations, down 0.1% from a year ago, to $6.5 billion. Management said consumers were becoming more “picky” about their spending, and price increases couldn’t fully offset the decline in restaurant visits. Revenue also fell short of expectations, down 12%, and margins shrunk on slightly higher costs.
Now, McDonald’s profit expectations for the second half of the year may be lowering. “Weak second-quarter results underscore weaker global same-store sales trends coupled with slowing industry trends,” Evercore analyst David Palmer wrote, noting that management needs to prove that some of its new value-focused menu items are helping to stabilize customer traffic.
Like McDonald’s, Wall Street’s expectations for S&P 500 earnings are likely too high. The index is expected to post fourth-quarter earnings per share growth of 13% year over year, while the long-term median growth rate is just under 7%, according to Trivariate founder Adam Parker. With economic and sales growth rates for many companies currently in the low single digits, not even at historically high levels, the median seems more likely to materialize.
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Parker wrote that the economy would need to improve for analysts to maintain their current earnings forecasts.
A cut in earnings estimates could be the catalyst for a market sell-off this year. While the market is usually able to weather forecast cuts, the S&P 500 is still too expensive to do so right now. The index is trading at just over 20 times projected EPS for the next 12 months, the upper end of its range since the Fed began raising interest rates in 2022. That means stocks generally fall when earnings numbers are cut.
This week, Meta Platforms, Apple, Microsoft and Amazon.com are among those reporting earnings, and investors will want to see a strong trend in consumer spending.
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If not, some of these stocks are expected to fall.
Email Jacob Sonenshine at jacob.sonenshine@barrons.com
