Insights from U.S. 3Q Earnings

After a near 100bps rise in 10-year Treasury yields in the U.S., the potential impact of tighter financial conditions and its corresponding effect on valuation multiples have contributed to the S&P 500 correcting by as much as 10% from its end-July highs. The third quarter U.S. earnings season (3Q23) provides an opportunity for investors to refocus on fundamentals. It also provides a chance to hear live from senior management teams with regards to current trading conditions, and understand views on the near-term outlook across a broad set of industries. Heading into the earnings season, expectations were for 3Q23 earnings to be down 0-1%, with commodity price-sensitive sectors such as Energy and Materials, and the key COVID-19 beneficiary sector in Healthcare, seeing particularly negative year-on-year earnings growth. Since 2016, the average earnings surprise for S&P 500 companies has been 8%. After earnings beats in 1Q23 and 2Q23 that were in line with this historical average, we are of the opinion that 3Q23 is likely to be similar. Compared to consensus expectations for 3Q23 earnings to be down 0-1%, we are more of the view that earnings could see growth of 1-2% by the end of the reporting season.

With ~90% of U.S. corporates having reported, there are some insights and observations we can draw from this quarter’s earnings season. Overall, earnings for the third quarter were solid, with 77% of companies beating consensus expectations, and the average beat in-line with its historical average of 8%. Earnings for the S&P 500 are tracking up 2-3% for the quarter compared to expectations of being down 0-1% several weeks back. Eight out of eleven sectors grew earnings in the quarter, which is a sequential improvement from 2Q23, and further evidence that more sectors are exiting earnings recessions that started in 4Q22.

We believe that a combination of rising interest rates over the past two months and a lack of upgrades to future guidance have investors guarded and concerned with regards to the future earnings outlook.

We do not share this negativity, and are constructive on U.S. equities on the recent pullback. By mid-2024, we view 4,650-4,750 on the S&P 500 as achievable on the back of earnings growth that is expected to accelerate in the subsequent quarters. Valuations have also moderated and are no longer a headwind, especially in light of the recent pullback in U.S. 10-year yields. In particular, we would highlight the technology sector as an attractive candidate to consider buying-the-dip. After five consecutive quarters of sub-trend earnings growth, the Technology sector is expected to finally return to low to mid-teens earnings growth, starting in 4Q23. More specifically, we are positive with regards to both the software and semiconductor sub-industries within Technology. Earnings drive stock prices, and this is expected to propel the Technology sector higher in the coming quarters. 

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