“Will earnings save the day?” with faded stock charts in the background, “Weekly Viewpoint” in the top left corner and the “Ally Do It Right” logo in the top right corner

Given recent volatility, there is hope corporate earnings can stabilize markets.

Several companies announced fourth quarter results over the past two weeks, but market volatility persists. Intraday moves in the market were unusual to say the least. At this week’s low, the Nasdaq Composite was on pace for its worst start to a year since 1980. Unprofitable companies found in the tech-heavy Nasdaq and Russell 2000 small-cap index suffered major losses. Nonetheless, earnings season is off to a strong start.

Bar graph titled Strength in Profit Growth tracks fourth quarter S&P 500 EPS Growth Estimates. Industrials (87.4%); Materials (44.3%); Info Tech (19.9%); Health Care (17.1%); Real Estate (10.1%); Communications Services (9.7%); Financials (8.8%); Staples (2.7%); Consumer Discretionary (2.2%); Utilities (0.3%); Energy (not measurable). The S&P 500 at 24.3% is highlighted in pink. Source: Ally Invest, S&P Capital IQ.

Favorable Narrative

Investors hope that market fundamentals, such as earnings results, can shift the focus away from fears of central bank policy changes and inflation. It might take a lot of good news to change the tone on Wall Street, though.

So far this reporting period, Q4 results have been solid with nearly 80% of companies reporting results ahead of Wall Street’s earnings estimates. Despite that, stocks have responded unfavorably. On average, nine of eleven S&P 500 sectors have declined the day results were reported. Will the narrative shift over the next few weeks as a greater proportion of companies report earnings?

The Good News

You wouldn’t guess it, but amid inflationary fears and rising labor costs, sales estimates are moving higher, and EBIT margins aren’t budging. According to S&P Capital IQ, S&P 500 revenue growth is expected to exceed 12% for the latest quarter, and the EBIT margins are expected to remain near a 14-year high at 16%.

Bar graph titled Maintaining Above Average Margins tracks the S&P 500 quarterly EBIT margins from January 2015 through estimates for all four quarters in 2022. The estimates for 2022 are all higher than every other quarter in that time frame. The 7-year average is 14.5%. Source: Ally Invest, S&P Capital IQ.

This is a sign that companies are passing higher prices on to customers while also managing their most significant costs. Fear is mounting that rising input costs and upward wage pressure will soon hit the financial statements of major U.S. companies, but margins continue to run wide.

Overall, the S&P 500’s Q4 EBIT margin is expected to exceed the average margin of the prior four quarters and be 3.4% points higher than the same quarter a year ago.

These are strong figures, but the bar is set high following some of the most impressive quarterly profit beats the market has ever seen. The S&P is expected to report Q4 earnings growth of more than 24%. That would mark the fourth consecutive quarterly EPS growth rate above 20%, albeit a deceleration from the prior two quarters.

Slowing Growth

Looking ahead, growth is expected to slow. Profit is forecasted at just 5% for the first quarter while calendar-year 2022 should see EPS increase by a more “average” 7%. This has made investors nervous, but average isn’t such a bad thing when it follows significant growth like that of 2021.

Even with fear of rising input costs, we think it is likely that companies will effectively manage higher expenses in the near term. They, as well as consumers, still have a considerable cash cushion relative to pre-pandemic levels. This will allow for the absorption of higher prices and drive higher spending. However, this will be an important trend to monitor as the year progresses.

Watch for better stock reactions.

For this earnings season, we expect a lower EPS beat rate relative to the previous six quarters. The upshot is that the recent market correction likely cooled expectations, so the back half of this reporting period could feature better post-earnings stock performances.

We find the Information Technology sector particularly interesting. Tech shares entered earnings season down 11% for the year, and Q4 EPS growth estimates barely budged. Sales growth is expected to be strong at more than 9% from a year ago, while the sector’s EBIT margin will continue to be market leading at above 30%. With valuations declining for many tech stocks heading into earnings season, good results could help stabilize the market.

The Bottom Line

2022 is off to a shaky start. Corrective price action among growth stocks and other risky assets has rattled confidence. Record S&P 500 earnings, particularly from the IT sector, should provide some fundamental stability despite fears of rising cost pressures and a Fed that is not as dovish as last year.

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Headshot of Lindsey BellLindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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