- The second-quarter earnings season could trigger the most painful stock correction since 2022, according to NDR.
- The research firm warned that growth will shift from accelerating to slowing toward 2025.
- “Even higher than expected levels may be needed to justify a rise in shares,” the analysts said.
Earnings season officially begins this week, bringing with it the most painful stock price correction since the 2022 bear market.
This is according to Ned Davis Research, which predicted what will be the most important results from the deluge of second-quarter results released over the next few weeks.
“The biggest risk is that year-over-year growth could shift from accelerating to slowing toward the end of 2024 and into 2025,” NDR strategist Ed Clissold said in a Thursday note.
This means that no matter how strong this quarter’s earnings results are, the stock market’s future success will depend heavily on corporate outlooks for the second half of the year.
According to NDR, here’s what investors should watch during second-quarter earnings season:
Growth forecast for the second half of the year
A typical pattern for Wall Street’s profit growth forecasts is that they tend to be overly optimistic at the beginning of the year and then gradually get revised downwards toward the end of the year.
So the question is not whether analysts will cut their second-half profit growth forecasts, but by how much.
“Last year’s growth rate was revised down by 4.8%, well below the long-term average of 8.1%, which is one reason why the S&P 500 has surged 24.2%. So far in 2024, the consensus has only been revised down by 1.3%, which is another reason why the index is up 18.1% so far this year,” Clissold said.
Current analyst projections call for S&P 500 earnings to grow 5.7% in the second quarter, 19.2% in the third quarter and 19.6% in the fourth quarter.
And this rosy growth outlook could ultimately lead to the stock market crashing, especially given expectations of slowing U.S. economic growth later this year.
Earnings beat consensus estimates
Eighteen months into the bull market, at least 78% of S&P 500 companies have beaten consensus estimates, a historically high number.
The broad trend of better-than-expected corporate earnings would need to continue for the next inevitable stock market correction to be postponed any further.
“Even higher-than-expected growth may be needed to justify a share price rise,” Clissold said. “Management lowered its second-quarter year-over-year growth guidance to 5.7% from 7.0% at the end of May. The lowered bar makes it easier to achieve growth that exceeds lofty expectations.”
Accelerating growth
“The idea that earnings growth is good for stocks makes intuitive sense, and while that’s true, there’s an important caveat: investors often look to the future and view extremely high year-over-year earnings growth as unsustainable,” Clissold said.
Profit growth has surged in recent quarters, but the biggest question for investors remains how sustainable that rate is, as slowing growth rarely translates into higher stock prices.
“Earnings are in a phase of rapid acceleration that is expected to continue through the third quarter per consensus estimates. During the second quarter earnings season, we will be watching for guidance on whether the expected year-over-year EPS acceleration materializes and for how long it will last,” Clissold said.
Magnificent 7 Stocks
Since the start of this bull market, much of the S&P 500’s revenue growth has been driven by a handful of mega-cap technology companies, including Nvidia, Amazon, and Meta Platforms.
Regarding revenue growth among the tech giants, Clissold said, “Five of the seven have grown by at least 20% compared to the first quarter of 2023, and three have grown by at least 100%.”
While this growth is strong, these companies face high hurdles to continue growing at a rate that will impress investors.
“The bar is high: the consensus is that five of the Mag7 are expected to grow at slower rates in the second quarter than in the first quarter. Even a big forecast overshoot may not be enough for Mag7 growth to continue to accelerate,” Clissold said.
493 stocks remaining
For the bull market to continue, the other 493 stocks in the S&P 500 need to start showing strength in terms of earnings growth, and this earnings season could be the quarter where that finally happens.
493 companies are expected to see a 1.1% increase in earnings in the second quarter, compared with a 5.7% decline in earnings in the first quarter. These companies ended up with a 0.3% increase in earnings in the first quarter.
“Analysts expect Magna 7 to continue to drive earnings growth, but the rest of the market will likely join in more aggressively. Outside of the mega-cap favorites, the bar is significantly lower,” Clissold said.
