Pick of the Litter
Mr. Market sees better days ahead – or whistles past the graveyard: Though the averages have stormed higher of late, including a 39% first-half jaunt for the tech-heavy Nasdaq 100 to mark its best such return on record, expectations for the upcoming second quarter earnings season trend in the opposite direction. Earnings per share across the S&P 500 will shrink by 7.2% relative to a year ago, analyst guesstimates collected by FactSet show, which would represent the weakest quarterly showing since the depths of the pandemic in mid-2020. Net profit margins will likewise ebb to 11.4%, analysts collectively expect, which would mark the seventh sequential decline in the last eight quarters.
That low bar duly presents the potential for a pleasant surprise, some reckon. “Rarely can you injure yourself falling out of a basement window,” Sam Stovall, chief investment strategist at CFRA Research, puts it to The Wall Street Journal.
The prospect of a trough in corporate earnings stands as a further salve for the bull crowd, as median four quarter returns on the S&P 500 stand at 5.1% after EPS growth reaches its cyclical nadir, data from Bloomberg show.
Investors are seemingly counting on it, as evinced by the S&P 500’s near 8% rally since the end of March, during which time the sell side tweaked year-over-year second quarter earnings projections lower by 2.5 percentage points in aggregate.
Indeed, Wall Street expects better days dead ahead for corporate America, anticipating a 0.3% year-over-year rise in third quarter EPS, before accelerating to a positive 7.8% pace in the final three months of the year. “The market is pricing in a very angelic [earnings] scenario, and we are very reluctant to buy into that,” Florian Ielpo, head of macro at Lombard Odier Investment Managers, told the Journal, adding that his firm has been lightening equity exposure in its flagship portfolio and maintains a roughly 25% cash position.
Fund managers likewise confront an historically top-heavy market backdrop following the blistering spring and early summer rally, as only 23% of individual equities have outperformed the S&P 500 over the three months through June, data from BofA show, easily the lowest share on record going back to 1986.
Outsized strength in the largest names has arguably left that cohort over its skis: Citing data from JPMorgan Asset Management, Chris Pavese, chief investment officer at Broyhill Asset Management, relayed in a LinkedIn post last week that the 10 largest firms in the S&P 500 command a near 32% combined weight in the broad index. That’s the highest such share since at least 1996, and well above the 21.5% contribution to S&P 500 earnings from that group over the last 12 months. “It’s going to be a great time for stock pickers as this unwinds, again,” Pavese predicts.