The pace of S&P 500 year-over-year earnings and sales growth slowed to eye-popping levels in the second quarter, benefiting from easy comparisons with Covid-ravaged 2020 and vigorous economic growth. While earnings growth has slowed, earnings are still expected to grow more than 21% year-on-year. Any color about the impact of supply chain disruptions and the timing of normalization will be important to forecasts. Finally, the impact of higher costs and the ability to pass on higher prices to protect profit margins will be closely examined. For the quarter, strong economic growth and consumer demand should allow most companies to offset cost pressures and outperform earnings expectations. While earnings will need to beat expectations, further guidance will be necessary with cost pressures and continuing concerns about earnings growth rates becoming more normal in 2022.
Eight S&P 500 companies are due to report earnings this week, but the primary focus will be on financials, and banks in particular. There are a few other companies on the calendar like Delta Air Lines (DAL). Financial reporting includes JPMorgan Chase (JPM), BlackRock (BLK), Citigroup (C), and Wells Fargo (WFC), so the larger banks will provide an idea of the operating environment. According to FactSet, financials should be around the bottom of the pack in earnings growth rates, with the consensus year-over-year growth estimate of -0.7%.
Bank stocks have sharply outperformed in 2022, rising nearly 10% year-over-year, which doesn’t seem to be in line with expected earnings declines. But under the surface, things are better than they appear. First, value stocks are significantly correlated with yields, so the recent rise in interest rates and less concerns about the Omicron variant’s weight on the pace of future economic growth have strengthened stocks. The financial price index comprises more than twenty percent. Second, banks have already reduced loan loss reserves which are reflected in headline earnings, so the year-over-year comparisons are not flattering but are hiding significant improvements. The core bank should have excellent income and benefit from credit growth. In addition, the wealth management and investment banking fees should be substantial.
While the year-on-year income from the industrial sector is expected to increase by more than 100%, this does not apply to the industry as a whole. Boeing (BA) and the airline posted huge gains year over year. This group of companies related to air travel reported losses in the fourth quarter of 2020. Despite some companies still expecting earnings losses, the relative improvement in earnings led to an increase in industry earnings. According to FactSet, income in the industrial sector should grow by 5.6% year-on-year if this group is excluded.
This season, the impact of higher costs and the ability to pass on higher prices to protect profit margins will be closely scrutinized across all companies. Labor costs will be a headwind for companies, with average hourly earnings growing at 4.7% year-over-year in December. Companies have rehired only 85% of the jobs they lost during the Covid-lockdown, which helps to offset higher labor costs. High commodity costs will also negatively affect the profitability of most companies. The rise in commodity prices outweighs that of oil, but as an example, a sharp rise in oil prices negatively affects the costs of many non-energy companies. The energy sector had negative earnings in the fourth quarter of 2020, but expected 66% year-over-year revenue reflects the oil price rebound in the fourth quarter.
Supply chain disruption remains a significant issue for this earnings season. These disruptions increased costs for most companies and reduced sales for companies unable to secure goods demanded by consumers. Increased shipping costs are almost certain by the end of this reporting season. While shipping costs have retreated from their highs, transportation costs remain high. Despite these challenges, strong demand and increased productivity could lead to actual fourth quarter results exceeding expectations.
In addition to earnings, Federal Reserve (Fed) Chairman Powell has a Senate reaffirmation hearing on Tuesday. Markets are already eyeing the first interest rate hike in March for a total of three hikes in 2022, but will be sensitive to any signs of a change in the timing and pace of the hike. Consumer inflation (CPI) readings for December, which are expected to be at a decade-high of 7% year-on-year, should add to pressure from the Fed to act in March.