The Stock Market Faces Next Test as Inflation Looms Over Earnings Season

Tightening monetary policy has slashed the rich valuations that stocks carried at the start of the year, leaving earnings growth as a key pillar of support. The reporting season for the second quarter will mark the latest test for the market as investors assess how profits have held up—and how companies are navigating the second half of the year.

Companies are battling headwinds on multiple fronts. Elevated input costs and challenging labor and supply-chain environments are weighing on earnings. Consumer spending has cooled as Americans deal with high prices at the pump and the grocery store. And a strong dollar has made U.S. products less affordable abroad, cutting into international sales.

“It’s going to be a pretty bifurcated earnings season,” said

Keith Lerner,

co-chief investment officer and chief market strategist at Truist Advisory Services. “It’s going to be a story of who doesn’t have that pricing power, and there’s going to be more differentiation.”

Investors will review earnings reports this week from big financial companies, including

JPMorgan Chase

JPM -0.31%

& Co. and

BlackRock Inc.,

BLK -0.66%

as well as other companies such as

PepsiCo Inc.

PEP 0.89%

and

Delta Air Lines Inc.

DAL -0.64%

They will also parse fresh readings on inflation that will likely influence the pace of the Fed’s rate-hiking plans.

Earnings among companies in the S&P 500 are projected to have risen 4.3% in the second quarter from a year earlier as of Friday, according to FactSet. That would mark the slowest pace of growth since the fourth quarter of 2020. For the year, profits are projected to rise 10%.

Analysts have lowered their near-term earnings estimates in recent months, but many investors say those projections are still too rosy. Expectations for the second quarter have fallen by a smaller margin than the historic average, while forecasts for the year have increased, FactSet found.

Estimates for other profitability metrics are still too generous as well, some investors say. The S&P 500’s expected net profit margin for the second quarter is 12.4%, above the five-year average and a hair higher than the previous quarter, according to FactSet.

“I’m absolutely gobsmacked that margins are expected to be as high as they are,” said

Hans Olsen,

chief investment officer at Fiduciary Trust. “It’s just this notion of hope over reality.”

Even if earnings fail to meet analysts’ estimates, some investors say they don’t expect stocks to crater because of how far they have retreated this year. The S&P 500 is trading at about 16 times expected earnings over the next 12 months. That is down from roughly 21 times earnings at the end of last year.

“The market has been anticipating this for a really long time,” said

Anna Rathbun,

chief investment officer at CBIZ Investment Advisory Services. “From here on out, it’s really dealing with inflation and what the companies are doing to work around it.”

Many companies have already telegraphed to investors that their businesses have weakened recently. The second quarter has seen the highest number of companies in the S&P 500 issue downbeat earnings guidance since 2019, according to FactSet.

Target Corp.

TGT -1.31%

and

Microsoft Corp.

MSFT -0.28%

warned in June that changing consumer tastes and a strengthening dollar, respectively, would dent their results. More recently,

Nike Inc.

NKE -0.18%

reported roughly flat quarterly sales and surging inventory amid changing consumer demand and supply-chain snarls. And spice maker

McCormick

MKC -0.29%

& Co. posted weaker-than-expected revenue, despite raising prices.

By sector, the S&P 500’s consumer-discretionary group—home to companies including Nike, Target and

Amazon.com Inc.

AMZN -0.68%

—has seen the largest downward revision of earnings estimates, according to FactSet. The financials, consumer-discretionary and utilities segments are expected to post the biggest declines in profits.

The energy sector, meanwhile, is predicted to be the greatest contributor to S&P 500 earnings growth, according to FactSet. Profits among the companies in the group are expected to more than triple. Without energy, earnings for the S&P 500 as a whole would be on pace to decline for the quarter, rather than increase.

Amid the growing pessimism, some investors are keeping their eyes peeled for any bright spots.

“The market’s probably looking for some positive news at this point,” said

Jon Maier,

chief investment officer of Global X ETFs. Any indications from companies of improving supply chains or easing inflation could be hopeful signs, he said.

As usual, investors are eager for any insight into what is in store for the rest of the year.

Kara Murphy,

chief investment officer of wealth-management firm Kestra Holdings, said she believes a downturn in corporate profits won’t show up until the latter half of 2022.

“Markets had priced in already a fair amount of this earnings slowdown, but they’ve not priced in an earnings recession,” she said. “We’re not at a point where we could say the market is cheap.”

Tightening monetary policy has slashed the rich valuations that stocks carried at the start of the year, leaving earnings growth as a key pillar of support. The reporting season for the second quarter will mark the latest test for the market as investors assess how profits have held up—and how companies are navigating the second half of the year.

Companies are battling headwinds on multiple fronts. Elevated input costs and challenging labor and supply-chain environments are weighing on earnings. Consumer spending has cooled as Americans deal with high prices at the pump and the grocery store. And a strong dollar has made U.S. products less affordable abroad, cutting into international sales.

“It’s going to be a pretty bifurcated earnings season,” said

Keith Lerner,

co-chief investment officer and chief market strategist at Truist Advisory Services. “It’s going to be a story of who doesn’t have that pricing power, and there’s going to be more differentiation.”

Investors will review earnings reports this week from big financial companies, including

JPMorgan Chase

JPM -0.31%

& Co. and

BlackRock Inc.,

BLK -0.66%

as well as other companies such as

PepsiCo Inc.

PEP 0.89%

and

Delta Air Lines Inc.

DAL -0.64%

They will also parse fresh readings on inflation that will likely influence the pace of the Fed’s rate-hiking plans.

Earnings among companies in the S&P 500 are projected to have risen 4.3% in the second quarter from a year earlier as of Friday, according to FactSet. That would mark the slowest pace of growth since the fourth quarter of 2020. For the year, profits are projected to rise 10%.

Analysts have lowered their near-term earnings estimates in recent months, but many investors say those projections are still too rosy. Expectations for the second quarter have fallen by a smaller margin than the historic average, while forecasts for the year have increased, FactSet found.

Estimates for other profitability metrics are still too generous as well, some investors say. The S&P 500’s expected net profit margin for the second quarter is 12.4%, above the five-year average and a hair higher than the previous quarter, according to FactSet.

“I’m absolutely gobsmacked that margins are expected to be as high as they are,” said

Hans Olsen,

chief investment officer at Fiduciary Trust. “It’s just this notion of hope over reality.”

Even if earnings fail to meet analysts’ estimates, some investors say they don’t expect stocks to crater because of how far they have retreated this year. The S&P 500 is trading at about 16 times expected earnings over the next 12 months. That is down from roughly 21 times earnings at the end of last year.

“The market has been anticipating this for a really long time,” said

Anna Rathbun,

chief investment officer at CBIZ Investment Advisory Services. “From here on out, it’s really dealing with inflation and what the companies are doing to work around it.”

Many companies have already telegraphed to investors that their businesses have weakened recently. The second quarter has seen the highest number of companies in the S&P 500 issue downbeat earnings guidance since 2019, according to FactSet.

Target Corp.

TGT -1.31%

and

Microsoft Corp.

MSFT -0.28%

warned in June that changing consumer tastes and a strengthening dollar, respectively, would dent their results. More recently,

Nike Inc.

NKE -0.18%

reported roughly flat quarterly sales and surging inventory amid changing consumer demand and supply-chain snarls. And spice maker

McCormick

MKC -0.29%

& Co. posted weaker-than-expected revenue, despite raising prices.

By sector, the S&P 500’s consumer-discretionary group—home to companies including Nike, Target and

Amazon.com Inc.

AMZN -0.68%

—has seen the largest downward revision of earnings estimates, according to FactSet. The financials, consumer-discretionary and utilities segments are expected to post the biggest declines in profits.

The energy sector, meanwhile, is predicted to be the greatest contributor to S&P 500 earnings growth, according to FactSet. Profits among the companies in the group are expected to more than triple. Without energy, earnings for the S&P 500 as a whole would be on pace to decline for the quarter, rather than increase.

Amid the growing pessimism, some investors are keeping their eyes peeled for any bright spots.

“The market’s probably looking for some positive news at this point,” said

Jon Maier,

chief investment officer of Global X ETFs. Any indications from companies of improving supply chains or easing inflation could be hopeful signs, he said.

As usual, investors are eager for any insight into what is in store for the rest of the year.

Kara Murphy,

chief investment officer of wealth-management firm Kestra Holdings, said she believes a downturn in corporate profits won’t show up until the latter half of 2022.

“Markets had priced in already a fair amount of this earnings slowdown, but they’ve not priced in an earnings recession,” she said. “We’re not at a point where we could say the market is cheap.”