Things to watch out for at the start of the fourth quarter earnings season


The pace of year-over-year S&P 500 profit and sales growth has slowed from staggering levels in the second quarter, which benefited from easy comparisons to Covid-ravaged 2020 and strong economic growth . Although the rate of profit growth has slowed, profits are still expected to grow by more than 21% year-on-year. The impact of supply chain disruptions and all colors on the timing of standardization will be significant for the forecast. Finally, the effect of higher costs and the ability to pass higher prices to protect profit margins will be closely scrutinized. For the quarter, robust economic growth and consumer demand should allow most companies to weather cost pressures and exceed earnings expectations. While earnings need to exceed expectations, forward guidance will be critical with lingering concerns about cost pressures and earnings growth rates becoming more normalized in 2022.

There are 8 companies in the S&P 500 expected to report earnings this week, but the focus will be on financials and banks in particular. There are a handful of other companies like Delta Air Lines (DAL) on the schedule. Financial reports include JPMorgan Chase (JPM), Blackrock (BLK), Citigroup (C), and Wells Fargo (WFC), so big banks will give a sense of the operating environment. Financial data is expected to sit at the bottom of the pack for earnings growth rates, according to FactSet, with consensus estimates for year-over-year growth of -0.7%.

Bank stocks have outperformed sharply in 2022, advancing nearly 10% year-to-date, which does not appear to be accompanied by lower expected earnings. But below the surface, things are better than they appear. First, value stocks have been highly correlated with returns, so the recent rise in interest rates and lessening concerns about the Omicron variant weighing on the pace of future economic growth have supported stocks. Financial stocks represent more than twenty percent of the value index. Second, banks have already reduced loan loss reserves that show up in overall earnings, so year-over-year comparisons are not flattering but mask significant improvements. Core banks’ earnings are expected to be strong and benefit from the growth in lending. In addition, the costs of wealth management and investment banking should be substantial.

While the industrial sector is expected to show year-over-year profit growth of over 100%, this does not apply to the industry as a whole. Boeing (BA) and the airlines generated a huge year-over-year gain. This group of airline-related companies posted a loss in the fourth quarter of 2020. While some companies still expect profit losses, the relative improvement in profits has caused the industry’s profits to surge. Manufacturing profits are expected to grow 5.6% year-on-year if this group is excluded, according to FactSet.

This season, the impact of rising costs and the ability to pass higher prices to protect profit margins will be under scrutiny across all businesses. Labor costs will be a headwind for businesses, with average hourly earnings increasing at a rate of 4.7% year-on-year in December. Companies have only rehired 85% of the jobs lost during the Covid lockdown, helping to offset rising labor costs. Higher commodity costs will also negatively impact the profitability of most businesses. The increase in commodity prices goes beyond oil, but for example, the sharp rise in oil prices is negatively impacting the costs of many non-energy companies. The energy sector posted negative profits in the fourth quarter of 2020, but the expected revenue of 66% year-on-year reflects the rebound in oil prices in the fourth quarter.

Supply chain disruptions remain a significant issue for this earnings season. These disruptions have both increased costs for most businesses and resulted in lost sales for businesses unable to obtain the goods consumers demand. Rising shipping costs will almost certainly be a familiar refrain by the end of this reporting season. While shipping costs have fallen from their all-time highs, transportation costs remain high. Despite these challenges, robust demand and increased productivity should allow actual fourth quarter results to exceed expectations.

In addition to the profits, Federal Reserve Chairman (Fed) Powell has his Senate reconfirmation hearing on Tuesday. Markets are already anticipating the first interest rate hike in March for a total of three increases in 2022, but will be sensitive to any indication of a change in the timing and pace of the hikes. Consumer inflation (CPI) readings for December, which are expected to hit a record 7% year-on-year, should add to the pressure for the Fed to act in March.

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