Markets in a Minute -Navigating Q2 Earnings: Tech Wins, Consumer Struggles, and What’s Next

Navigating Q2 Earnings: Tech Wins, Consumer Struggles, and What’s Next

Key Takeaways

1.     Mixed but Strong Q2 2024 Results: 78% of S&P 500 companies reported positive earnings surprises, exceeding the 10-year average. However, the magnitude of these surprises is below the average, with only a 3.5% surprise rate compared to the usual 6.8%. The Magnificent 7 has significantly contributed to the S&P 500’s 10.8% earnings growth.

2.     Sector-Specific Trends: Consumer discretionary and staples sectors are underperforming, with many companies missing earnings estimates due to shifts in consumer behavior and macroeconomic headwinds. Large technology companies continue to show strong earnings, though the growth rate is less impressive than in previous quarters.

3.     Cautious Forward Guidance: While 54% of companies issued positive guidance for fiscal year 2024, guidance for Q3 2024 is more cautious, with 55% issuing negative guidance. Small capitalization stocks briefly rallied but then sputtered as new concerns about economic growth emerged.

With second quarter earnings season almost complete, companies have provided an important window into economic trends. As of August 12, 91% of S&P 500 companies have reported their Q2 2024 earnings. While the results have been mixed compared to expectations, earnings growth remains strong despite some softer economic data. At the sector level, some macroeconomic trends are becoming clearer, particularly in the consumer discretionary sector. Nearly 75% of consumers have said they have traded down to lower-priced products, often by buying less or delaying purchases. High-flying tech names are still delivering earnings beats, but the margin of outperformance has narrowed compared to the last six quarters. Notably, the “Magnificent 7” have been responsible for nearly 30% of the S&P 500’s earnings growth, which currently stands at 10.8%. If this growth holds, it will be the highest since Q4 2021.

S&P 500 Earnings Growth (Year Over Year): Q2 2024

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Note: views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Data as of August 9, 2024. 

Earnings Surprises

While earnings have broadly been robust, this season has provided hints of change in the broad economy. 78% of S&P 500 companies are reporting positive earnings surprises, which is better than the 10-year average of 74%. However, the size of these surprises is smaller, averaging 3.5% compared to the 10-year average of 6.8%.

Nine out of the 11 sectors are reporting year-over-year earnings growth, with utilities, tech, financials, health care, and consumer discretionary seeing double-digit growth. Health care and real estate lead with 84% of companies in those two sectors beating earnings estimates, while consumer discretionary and consumer staples are lagging behind with the lowest percentages of companies exceeding expectations.

Despite strong earnings performance overall, the market’s reaction to earnings surprises has been more subdued this quarter, rewarding positive earnings surprises by less than usual and penalizing negative surprises by more than usual. On average, a negative surprise has led to a 3.8% drop in share price, vs the 5-year average decline of 2.3%.

Sector Trends

Companies in the consumer discretionary and consumer staples sectors have been struggling, with many missing earnings estimates. This reflects a broader trend of a softening consumer, as indicated by macroeconomic data. Key themes from
earnings calls include:

–        Shifts in consumer spending due to the macroeconomic environment, with consumers trading down to lower priced products. Managements expect these shifts to persist

–        Many large restaurant and retail chains giving cautious to negative forward-looking guidance

–        Earnings and revenue misses and the lowest percentage of earnings beats

Amazon has been a major contributor to the sector’s earnings growth; without Amazon, the year-over-year earnings growth rate for the consumer discretionary sector falls from +11.9% to -3.5%

While the technology sector continues to be the bright spot in earnings, growth is not quite as impressive as prior quarters. Most big tech firms continue to beat revenue and/or earnings per share estimates, albeit by a smaller magnitude than
before. The sector continues to be the dominant contributor to the S&P 500 earnings growth rate. Noteworthy trends include:

–        Soft revenue and earnings beats among the largest companies

–        Margin expansion among the largest companies

–        Increased forward-looking estimates for capital spending, which could hurt margins

–        Little cautionary language with respect to the macroeconomic environment

The technology sector, and the market as a whole, remains heavily dependent on the earnings power of a handful of names, including Nvidia, which is yet to report. The semiconductor company is expected to be the largest contributor to year-over-year earnings growth for the sector; without Nvidia, the earnings growth rate for the sector would fall from +18.7% to +9.3%.

S&P 500 Sector Earnings Growth Rate Contributors / Detractors (Year-Over-Year): Q2 2024

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. It is not possible to invest directly in an index. Note: views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. Source: Kestra Investment Management with data from FactSet. Data as of August 9, 2024. 

Looking Ahead

Guidance for the remainder of the year remains optimistic, while companies approach the upcoming quarter with a more conservative outlook. 272 companies have issued guidance for the current fiscal year, with 54% issuing positive guidance while the remaining 46% have issued negative guidance. The sample size of companies issuing guidance for Q3 is smaller at just 86 companies. Third quarter guidance is more cautious, with 45% issuing positive guidance for Q3 and the remaining
55% issuing negative guidance. The S&P 500 is expected to see a 10% earnings growth rate for 2024, slightly down from the 11% going into the quarter.

Small caps experienced a brief rally due to softer-than expected macroeconomic data, which hinted at a Fed rate cut in September. However, the rally faded in the following weeks as hotter-than-expected unemployment data raised fears of a
recession. As we move into 2025, earnings growth is expected to broaden out, with small- and mid-cap companies potentially leading the way over large caps.

Actual vs Expected Earnings Per Share