US earnings momentum is slowing, analysts noted, amid a big week for Wall Street with around 45% of the S&P 500 market capitalization reporting.
The level of earnings growth in the third quarter has decelerated to the softest level of growth since the pandemic-affected end of 2020, UBS pointed out, with companies also trimming guidance for the fourth quarter.
Analysts at Wedbush said it was a "moment of truth" for big tech, with an earnings season that will "either expose the negative underlying fundamentals across the tech space and cause massive earnings cuts into 2023 along with further multiple compression or instead prove that the bearishness and the demise of growth tech was premature and many pockets of tech are holding up well despite the dark storm clouds".
Later today, tech heavyweights Microsoft Corporation (NASDAQ:MSFT) and Google owner Alphabet Inc (NASDAQ:GOOG) both report, along with Spotify and Twitter – while later in the week it will be the turn of big tech names Amazon, Apple, Intel, Meta Platforms, along with those in other sectors this week including Aon, Boeing, Bristol-Meyers Squibb, Caterpillar, Chevron, CME, Exxon Mobil, Ford, Kraft-Heinz, MasterCard and McDonalds.
While close to two-thirds of companies are beating earnings guidance, earnings beats are so far below the 75% average of recent years, which UBS chief investment officer Mark Haefele said “is especially striking because third-quarter estimates had been cut by nearly 7% over the last three months, suggesting that the bar was low”.
Showing how earnings growth has slowed, he noted that it was now tracking at the low end of UBS’s 3–5% year-over-year expectation, down from 8% in the second quarter.
This is the slowest earnings growth since the pandemic-affected final quarter of 2020.
“We expect this decelerating trend to continue,” said the UBS CIO, with 7% earnings growth forecast for S&P 500 companies in 2022 but a contraction of 4% next year.
Guidance for the fourth-quarter for companies that have reported so far have fallen by about 2%, the bank noted.
As the consequences of restrictive monetary policy for the economy and corporate profits are “not well reflected” in consensus forecasts, this increases the potential for “further disappointments to come”, said Haefele.
Companies are facing the challenging combination of weakening demand, rising workforce costs, tough comparisons with strong pandemic-rebound growth in 2021 and early 2022.
“Stresses in the financial system, which could presage a sharper slowdown in activity, are elevated, as recent events in the UK pensions market demonstrate,” he said, with leading indicators such as new orders pointing downward.
International conditions are also becoming more challenging, with growth under pressure in both China and Europe, to hit Wall Street’s global giants.
But UBS said the earnings season “could still produce many surprises”, the outcome so far is consistent with the bank’s favouring of more defensive parts of the market, such as healthcare and consumer staples.
“As the Federal Reserve continues to tighten, with a further 75-basis-point rate rise expected from next week’s policy meeting, the tech sector looks especially vulnerable, given its heavier reliance on more distant profits and still demanding valuations compared to value sectors,” Haefele said.
A 19% fall in the S&P 500 for the year to date does “not yet fully reflect a bear case scenario,” and the market has not become cheaper relative to bonds, he added.
Wedbush analyst Daniel Ives was more bullish, saying data checks suggest enterprise software and cyber security are holding up well, though the stronger dollar and other currency swings will add another incremental headwind for tech stalwarts and negatively impact guidance going forward.
"That said, the FX dynamic is already baked into whisper numbers in our opinion as the laser focus on the Street remains: is enterprise spending holding up? If so, what pockets?
"This is the big question as in the softer macro its easy to punt on discretionary projects and tighten IT budgets as darker storm cloud approach into 2023."
Ives said cyber security earnings "should hold up well", as cloud transformation projects, cyber security spending, data analytics build-outs, and hybrid cloud integrations "continue to get green lighted by CIOs as the budgets are generally in place into 2023 with strong ROI around these deals".
Some smaller deals have been pushed and some pricing pressure emerged on "isolated deals" but overall he felt the environment is "holding up much better than is being priced into these stocks in our opinion".
"Clearly the path of least resistance in this market is to be bearish, focus on the macro, higher rates, end of easy money, and say valuations of tech stocks are doomed for the foreseeable future.
"On the contrary, we believe 3Q EPS season kicking off this week will be a positive catalyst for tech stocks and ultimately prove out that fundamentals in pockets of software, cyber security, and some other areas of tech (iPhone sales, supply chain issues easing) will be better than feared with valuations already reflecting massive negative revisions ahead."