In a note to clients Tuesday, Bank of America strategists previewed the impending second-quarter earnings season as investors brace for a fresh batch of results after a strong first quarter.
In the first quarter, US companies managed to deliver strong earnings, with earnings per share beating consensus estimates by 3%. This came against the backdrop of easier year-over-year comparisons, reflecting a 6% decline in the second quarter of 2023 compared to a 3% decline in the first quarter of 2023.
Bank of America strategists said they expect growth to rise 2% in the second quarter, which would be “in line with the historical average and the smallest since the fourth quarter of 2022.”
Despite the strong start, macroeconomic conditions have weakened since the first quarter. The Economic Surprise Index is at its lowest level since June 2015, suggesting that second-quarter earnings could fall by 3%. However, historical data provides some optimism: After the global financial crisis, earnings per share beat expectations 91% of the time when the Economic Surprise Index was negative, with an average decline of 3%.
“It is rare for a stock to fail to achieve earnings per share,” the strategists said.
Bank of America’s preliminary Q2 forecasts suggest that while economic indicators may point to a weaker quarter, analysts have maintained their earnings estimates since March. That’s a significant departure from the typical trend of 4% earnings cuts on average, suggesting analysts are confident in their forecasts.
“Earnings revision and guidance improved in Q2, and Bank of America’s indicators suggest growth is resilient. Conversely, we estimate that the exchange rate was a headwind to sales of about 100 basis points, the largest impact since Q1-23,” the strategists noted.
According to the Bank of America team, one important factor to watch this earnings season is the expected shift in growth dynamics. The second quarter is expected to mark the first quarter of EPS growth for the “other 493” companies in the region, excluding the Super Seven, since the fourth quarter of 2022. In contrast, the Super Seven’s growth is expected to slow for the second consecutive quarter and continue to slow in the third quarter.
“Growth is expanding and the market should expand too,” the strategists noted.
Bank of America also stresses that while demand is the primary driver of earnings, inflation is a lagging indicator. The good news is that the expected demand recovery in the second half of the year is not overly optimistic.
Excluding the Big Seven, the consensus expects real sales growth of just 1% in the second half. This modest forecast is supported by the end of one of the most severe inventory-reduction cycles in history. The ratio of new orders to inventories has also improved, suggesting that the inventory correction phase is coming to an end.
“While the expected 14% EPS growth in Q4 seems high, more than 60% of the growth comes from Mag. 7, one-time healthcare expenses from last year, and financials,” the Bank of America note adds.
Finally, Bank of America noted that the upcoming earnings season should also provide new insights into the impact of AI investments.
While AI’s profitability is likely to take longer than initially anticipated, big tech companies are continuing to invest heavily. The consensus forecast is a 34% increase in capital spending by big computing companies in 2024, totaling about $200 billion.
“The key question is whether they will continue to invest aggressively even if the monetization process is pushed. At the moment, there are no signs of investment slowing down, and we believe we are in the early stages of the AI investment cycle,” the strategists said.
