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U.S. companies are about to give us a look into their worst quarter since the Great Financial Crisis.  

Currently, Wall Street analysts expect second quarter earnings per share (EPS) growth to decline 45%. While the earnings bar has been lowered significantly for all companies since the pandemic struck, results from the most recent quarter will likely be mixed, with some companies beating those lowered estimates and some missing.  

Individual stocks’ reactions to the results will vary widely. Key drivers will not just be related to profits from the quarter, but also to how the stock has performed leading into the report and what investors can glean from corporate management commentary about future growth prospects. Increased volatility is expected as companies report over the next several weeks.  

While the second quarter is not going to be pretty, the good news is expectations for next year have stabilized. And future profit potential has historically been a key driver of market direction. Even with increased volatility near-term, investors are likely to still focus on 2021 earnings estimates. That could be a good thing: S&P 500 earnings are projected to fully recover by next year. If that target can hold steady, the market will likely be able to at least tread water for now.  

Chart shows year-over-year changes in S&P 500 earnings per share from 2001 until 2020, with additional estimates from Q2 2020 through Q4 2021. The estimate for Q2 2020 is -45%, and the expectation is that by end of 2021 there will have been a full recovery. 

Open to Interpretation 

S&P 500 members are scheduled to start reporting second-quarter earnings en masse on July 14. Experts think it could be the worst season for profits since the fourth quarter of 2008, the deepest decline in earnings during the Great Financial Crisis. 

The first-quarter earnings seasonwhich reflected the first month of the coronavirus pandemic, turned out to be a surprisingly cheery period for investorseven though S&P 500 profits fell 12% year over year. Investors and Wall Street alike expected the results to be much worse than they actually were, and companies painted the pandemic as a temporary blip. The S&P 500 advanced more than 10% from April 13 (when the reporting season kicked off) to the end of May. 

The reaction came despite Wall Street dramatically slashed earnings estimates after most companies withdrew guidance. Fast forward three months, and investors are still anticipating that the second quarter will be the bottom in earnings declines for this recession. The economy has partially reopened, and we’re watching a fierce economic recovery that most Wall Street economists have underestimated so far. Experts predict S&P 500 profits fell 45% year over year in the second quarter, with a 26% drop expected in the third quarter. To us, it feels like the bar could be too low once againand a lower bar should be easier for most companies to hurdle. 

However, the reaction to results will likely be mixed, varying by companyBeating earnings estimates won’t guarantee a stock will soarA low earnings bar could be offset by a higher performance bar, for example. There’s a lot of optimism priced into the market, so individual expectations could be high (even though Wall Street’s forecasts are low).  

There will be a lot left up to interpretation. Many companies have withdrawn their own forecasts for the next few quarters since the coronavirus pandemic started. Who can blame them? Even so, we don’t expect those companies to throw out new forecasts in upcoming earnings calls, so investors will be left to read between the lines in management comments. A key focus will be on trends since the quarter ended. There are signs that the resurgence in cases is leading to pockets of slowing of economic activity that had previously picked up. Management outlooks and price performance should always be taken into consideration when earnings are released, but they could take on more meaning this time around given the dichotomy in the market. Fewer hard numbers from companies could lead to more confusion, and that confusion could result in some outsized market moves.  

Sector Surprises 

Overall, it’s shaping up to be a rough season across the board. Wall Street analysts project that profits declined year over year for all 11 sectors, the first time that’s happened since at least 2002 (the beginning of our data).  

chart shows second quarter year-over-year earnings estimates by S&P 500 sector. Estimates are as follows: utilities -2.1%, information technology -9.1%, consumer staples -14.4%, health care -17.6%, communication services -35%, materials -38.4%, S&P 500 -45.1%, financials -48.7%, real estate -62.6%, industrials -87.7%, consumer discretionary  -114.4%, energy -154.2%. 

A bleak earnings season could be a setback for a rally carried by fewer stocks these daysThe S&P 500 rose 1.8% in June, yet about half of its member stocks finished the month lower. Because of this, the rally may be at risk if investors view earnings reports as a gut-check for high-flying stocks.  

Results for technology stocks, the best-performing sector this year by a mile, could be the most heavily scrutinized this season. Wall Street has set technology’s earnings bar a little higher, predicting technology company profits only fell 9.2% last quarter. That’s an encouraging sign, and it could reinforce tech’s status as the market leader. But high expectations could be the sector’s downfall as investors will be on high alert for any negative cues. 

Consumer discretionary will be another sector to watch. The sector has flourished lately, but there’s a glaring mismatch between the sector’s performance and its profits. S&P 500 consumer discretionary stocks’ earnings slid 114% in the second quarter, estimates show, the second-worst forecast among sectors. Investors may have caught on to the fact that the consensus has cut earnings expectations for the consumer discretionary sector by more than any other sector heading into the reporting period, thus, lowering the bar for the sector.  

It’s important to note that Amazon makes up about 47% of the market cap of this group, and its spectacular run this year has helped pull the sector’s performance along. But that concentration also means Amazon is under pressure to deliver. Last season, Amazon slid nearly 8% the day of its first-quarter earnings release (April 30) when it reported worse-than-expected profit, and management communicated a bleak outlook. CEO Jeff Bezos effectively lowered the bar for the e-commerce giant by committing to spend about $4 billion to keep customers and employees safe during the COVID-19 crisis. This time around, investors seem to expect a solid report given the stock is about 29% higher since its last earnings report.  Even if Amazon delivers a positive report, it may not be enough in investors’ eyes.  

Good and Bad Surprises 

It’s shaping up to be an unusual earnings season, and there are sure to be some good and bad surprises. Investors’ reactions are always tough to gauge, but we have a feeling they’ll be optimistic enough to shield the overall market from a significant earnings-related slide. The potential bottom could be enough comfort for now. 

Head here for our full Q3 outlook.  

The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.

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Headshot of Lindsey BellLindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.