Wall Street signals profit slump may be over, boosts forecasts

Easing inflation is driving expectation of positive earnings.

Wall Street analysts are boosting US earnings forecasts even before results start rolling in, signaling that the worst of the profit slump is likely over as ebbing inflation eases the pressure on a broad swath of industries.

That’s pushed an indicator known as earnings-revision momentum — a gauge of upward-to-downward changes to expected per-share earnings over the next 12 months — to roughly positive territory and well over its November 2022 low of negative 70%, according to data compiled by Bloomberg Intelligence. It’s the most positive reading ahead of an earnings season since the first quarter of 2022, with forecasts recently only getting marked up after executives deliver the latest guidance.

The moves are a sign of growing optimism as companies get ready to start releasing third-quarter reports. While profits for S&P 500 firms are forecast to drop for a fourth straight quarter, it may mark the end of the decline as analysts expect per-share earnings to rebound in the final three months of the year.

The outlook is providing support for the stock market’s rebound this month on optimism that the Federal Reserve is poised to end its interest-rate hikes with economic growth still intact, even though some industries are still being squeezed by inflation pressures and a tight job market.

“Analysts have been forced to shift their earnings expectations, with many growing more bullish about profit growth in the year ahead and what companies can handle in the coming quarters without the headwind of the Fed continuing to raise rates,” said Jimmy Lee, chief executive of The Wealth Consulting Group.

Many sectors in the S&P 500 have posted improving earnings revisions. Energy producers have lead the way in recent weeks as crude prices climb, along with technology companies and those that rely on discretionary consumer spending, BI data show. Utilities and real estate remain among the weakest industries.

After cost-cutting efforts, tech and communication-services companies are expected to see strong improvements in profit margins during the third and fourth quarters, while staples, health care and materials are anticipated to see continued pressure.

The divide underscores the still uncertain outlook in some industries as the impacts of the Fed’s rate hikes ripple through the economy and inflation remains elevated. As a result, the upward profit revisions may need to become more widespread before there’s a notable turnaround in investors’ confidence, according to Timothy Chubb, chief investment officer at Girard, a wealth advisory firm backed by Univest.

“My biggest concern is to what extent and for how long can companies pass on price increases to consumers before it significantly impacts demand,” Chubb said. “We may have passed the trough in profit pain, but at what point will high rates and elevated wages start to force companies to lay off workers and prop up margins instead?”

The biggest stocks in the S&P 500 have dominated the earnings recovery this year. The five biggest companies — including Apple Inc., Microsoft Corp. and Alphabet Inc. — expected to post a 29% profit expansion in the three months through September from a year ago, BI data show. That compares with an earnings contraction of 1.1% for the S&P 500 overall and a 4.3% drop without those top five firms.

Still, it’s possible the S&P 500 may end its profit recession in the third quarter instead of the fourth. That’s because companies have largely been exceeding analysts’ forecasts. Over the past three decades, around 60% of companies typically beat profit estimates in a given quarter. But since early 2021 it’s been around 80%, BI data show.

“Analysts cut expectations too much in recent quarters, so companies have been able to beat more easily on profit growth and will likely continue to do so this earnings season,” said Wendy Soong, senior analyst at BI.

Traders are looking ahead to Thursday’s figures on consumer prices to solidify expectations about the path of monetary policy and its impact on the economy and company margins.

On Wednesday, the Labor Department reported that prices paid by producers rose at a faster-than-expected pace in September. But futures markets were still betting that the Fed’s rate hikes are likely over. The focus turns next to US consumer price data later on Thursday, which economists are forecasting to show a further easing in inflation.

That optimism has been fueling US stocks futures, with cash markets set for fifth straight day of gains.

“I’m hopeful that we end up with a ‘Goldilocks’ scenario where inflation falls further and the Fed is becoming dovish quicker, leading to sooner rate cuts down the road,” Wealth Consulting Group’s Lee said. “If that happens, we’ll get a massive rally in risk assets later this quarter, with fund managers chasing benchmark returns that they’ve missed out on.”