What to watch for in Q2 earnings season

As second-quarter earnings season begins in the U.S., tight labour markets may squeeze profit margins, putting earnings under pressure in the second half of the year, according to the BlackRock Investment Institute.

The asset manager’s weekly market commentary said that S&P 500 earnings forecasts have risen in recent months alongside markets. However, as with the narrow market boom driven by a small group of large tech firms and buzz around artificial intelligence (AI), BlackRock said stripping out the mega-cap tech stocks shows forecasts that are basically flat.

With labour markets remaining tight, BlackRock said wage gains are likely to start cutting into corporate profit margins.

“Tight labour markets have caused employers to up wages to attract new hires,” the report said. “Broad worker shortages could incentivize companies to hold onto workers — even if sales decline — out of fear they won’t be able to hire them back. This outlook poses the unusual possibility of ‘full employment recessions’ in the U.S. and Europe.”

Consumers have continued to support earnings with strong spending since early in the pandemic, but BlackRock warned those pandemic savings may be exhausted later this year, adding to earnings pressure.

The asset manager said health care and technology could hold up better than other sectors, benefiting from “mega forces” such as aging populations and AI.

“These forces are driving profits now and in the future — and markets are reacting, as with this year’s tech rally,” the report said. “Plus, we like health care’s more attractive valuations and generally steady cash flow during economic downturns.”

In a mid-year outlook report, Purpose Investments noted that the negative forecasts at the beginning of the year haven’t come to pass, with markets rebounding and a long-awaited recession not necessarily looking any more likely.

However, Purpose chief investment officer Greg Taylor said those previous forecasts weren’t necessarily wrong — they may have just been early. Second-quarter earnings reports combined with inflation data — the latest of which comes on Wednesday for the U.S. — will give a better sense of how the rest of the year will go, he said.

“During summer, when many are on vacation, a choppy sideways market with no direction is probably the most likely scenario as the bulls and bears square off,” Taylor wrote.

“Then as we head into the seasonally weaker period of September and October, the risk is that earnings will begin to contract and the momentum that carried the technology stocks peters out, so we get our long overdue correction.”

Meanwhile, Kevin McCreadie, CEO and chief investment officer with AGF Management Ltd., wrote in a recent note that the idea of a “soft landing” is spreading without much evidence to back it up. He expects interest rates to eventually catch up to the economy and lead to a recession.

“Ultimately, the bull run in U.S. stock markets doesn’t quite jibe with the reality of the current environment and in some respect (i.e., its narrowness) seems almost like a mirage,” McCreadie wrote. “That doesn’t mean it can’t continue, but it will surely take more than wishful thinking to keep it going.”