12 June 2023 Equities | US

Earnings Outlook: Major Indices Face Headwinds

By John Tierney
4 min read

Summary

The S&P 500 has received kudos for exiting bear market territory.
Not to rain on the parade, but it is still 11% short of its high in early 2022. Meanwhile, NASDAQ 100 is 14% below its peak.
To reach previous highs will require earnings growth – but earnings have flatlined in recent quarters.
We still like the Russell 2000 (RTY) and regional bank ETF KRE as tactical trades.
Only seven companies report this week, but they include tech bellwethers Oracle and Adobe; and grocery giant Kroger.

What We Learned Last Week

The S&P 500 (SPX) received a high-five from investors and the business press last week on officially ending bear market status – up 20% from the low. The NASDAQ 100 (NDX) crossed that threshold in late March – it is now up 36% from the December 2022 low. The laggard small-cap Russell 2000 is now up 13.2% from the lows, but still 31% below the highs.

We prefer a less generous definition – exiting a bear market entails passing the previous market high. By that measure, SPX is 10.8% short, NDX is 14% short, and RTY a whopping 1% underwater.

What will it take to get there? Earnings growth. Roughly speaking, the underlying driver of equities is earnings. After a period of spectacular growth during the pandemic, both 12M trailing earnings and forward earnings have flatlined in recent quarters (Chart 1). Unless animal spirits go crazy, the SPX will struggle to rally much from present levels.

Federal Reserve (Fed) policy is the other key variable – a rate cut would certainly benefit equities, even if earnings outlooks change little, due to a lower discount rate on future cash flows. The risk is that the rate cut might come amid rising unemployment, a slowing economy, and softer earnings, although it could cushion any market selloff.

Both NDX and RTY show a similar earnings pattern, suggesting (from a fundamental standpoint) that further gains will be harder to achieve.

Still Long KRE and RTY – Last week, we suggested that RTY and the regional bank ETF KRE worked as tactical trades that could benefit in the current upbeat environment. RTY rallied 2%; KRE was up 3%, while SPX eked out a 0.4% gain (Chart 2). We still think these trades make sense.

We are finally getting more visibility on prospective regulatory changes, which will help put a floor under valuations. We also expect many regional banks will show good earnings and progress on improving balance sheets during the upcoming Q2 earnings season. Still, regional banks face many challenges, which make it unlikely they will return to pre-Silicon Valley Bank crisis highs soon.

RTY has tracked the regional banks, largely because of concerns about a credit crunch that would hurt smaller companies dependent on bank loans. It should continue to outperform with KRE for now. Investors can hold RTY via the IWM ETF.

Again, we stress these are tactical trades. Should market sentiment turn negative, we would unwind them.

The Week Ahead

The big events next week for market sentiment will be inflation reports (CPI on Tuesday; PPI on Wednesday) and a Fed meeting on Wednesday.

Only seven companies report this week, but some are key names that investors will likely focus on.

Tuesday

Oracle (ORCL) is a key bellwether for corporate IT CAPEX. Will it confirm the slowing trend that many other tech companies have highlighted?

Wednesday

Homebuilder Lennar Corp will surely confirm what we have heard from other homebuilders – that homebuyers are turning to new construction due to the dearth of existing homes for sale.

Thursday

Adobe (ADBE) is another tech bellwether for both corporate CAPEX and consumer products.
Grocery giant Kroger (KR) offers a ground level perspective on how consumers are responding to massive price hikes by many food product companies.