Stock market recovery ‘fragile’ after investors hoped ‘earnings bandage would be ripped off’, says RBC

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The recent stock market rally is “fragile” due to the possibility of further downward earnings revisions around 2023, according to RBC Capital Markets.

Revenue and earnings per share, or EPS, forecasts have started to decline for the second half of this year and 2023, although second-quarter company results are “much better than expected”, it said. Lori Calvasina, Head of US Equities. strategy at RBC, in a research note Wednesday.

While the “resilience” in earnings seen after the release of more than half of the S&P 500’s second-quarter results is “good news” for the U.S. stock market, she said the “bad news” is the risk of further earnings downgrades later this year. .

As companies began reporting second-quarter earnings, “many U.S. equity investors hoped the ‘band-aid would get ripped off,’” Calvasina wrote. That is, “the company’s outlook and sell-side EPS guidance would be significantly reduced, fully baked into an economic downturn and allow them to start buying stocks with some confidence about the real situation of multiples”.

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The S&P 500 is down nearly 13% so far this year based on Wednesday afternoon trading at around 4,161 according to FactSet data, when last checked.

According to the RBC report, much stronger-than-expected second-quarter results “paint a picture of corporate earnings resilience and support the narrative that any future (or current) economic downturn is likely to be short-lived and superficial.” .

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“This has supported equity prices over the past few weeks, but looking ahead, it also tells us that the recovery in equities is fragile given the possibility of further downward earnings revisions heading into 2023. “, said Calvasina. “The forecast is falling, but maybe not enough.”

Meanwhile, companies beating on EPS in Q2 are “rewarded with stronger-than-usual outperformance, and companies that lag benefit from shallower-than-usual underperformance,” she said. writing.

So far, sectors “standing out” include energy, real estate investment trusts and utilities for earnings resilience, with all three areas helping to keep 2022 EPS growth forecasts from “falling too low.” for the S&P 500, according to RBC. Technology also stands out, as it’s a sector “where earnings sentiment has already been deeply negative and beat rates have been elevated” in the second quarter, Calvasina said.

RBC CAPITAL MARKETS NOTE DATED AUGUST. 3, 2022


“On the other hand, technology had one of the highest percentages of negative earnings and sales reviews, as well as consumer discretionary and communication services,” Calvasina said.

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RBC has an “overweight in technology as a recession rebound trade,” and recently upgraded energy to overweight it and REITs to market weight, according to the note.

U.S. stocks were trading sharply higher on Wednesday afternoon as investors digested earnings reports and new economic data showing factory orders continued to grow in June as the economy slowed.

The Dow Jones Industrial Average DJIA,
+1.29%
rose 1.5% in afternoon trade on Wednesday, while the S&P 500 SPX,
+1.56%
gained 1.8% and the tech-heavy Nasdaq Composite COMP
+2.59%
jumped 2.7%, according to FactSet data, when last checked.

“We’ve also been keeping tabs on the labor discussion, where a number of tech companies have highlighted a slowdown in hiring,” Calvasina said. “Outside of tech, however, the conversation about work always seems to focus on the challenges companies face in finding it.”

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