A group of businesspeople in an office in the evening or at night, using computer.

Corporate earnings season unofficially kicks off when JPMorgan Chase reports results Thursday morning next week.

Given the economy’s quick pivot from stellar growth late last year to the real possibility that we are currently in a mild recession means this earnings season will be watched very closely. Just in the last several weeks, big-name companies such as Microsoft, Micron, and even smaller players like Bed Bath & Beyond reduced their profit outlooks. Several reasons were cited ranging from soft consumer demand to ongoing supply chain issues to foreign currency headwinds.

There’s been a rallying cry on Wall Street for earnings estimates to be reduced in a significant way to reflect the current operating environment and to match the first half price performance of the stock market. On the surface it’s easy to make that call, but when you take a deeper dive, there are reasons to believe 2022 estimates may not be so off base, at least near-term.

Slower earnings growth expected

While the headlines that get the most airtime are those that fit the narrative that earnings estimate must be reduced, yet not everything is doom and gloom. In the past few weeks, a handful of companies affirmed or even boosted guidance. Household names like FedEx, General Mills, and General Motors have had better things to say about the macro environment as well as firm-specific operations.

Overall, profits for the S&P 500 are expected to have increased by 5.0% in Q2, based on S&P Capital IQ data. That would be the weakest quarterly earnings advance since Q4 2020. That said, a slowdown in growth after a year where earnings grew 47% is expected. Making things more difficult in the second quarter is the outsized growth achieved in the same quarter last year. The S&P 500 grew earnings by 89% in the second quarter of 2021. It’s hard to reach above average, or even average, growth rates in a situation like that.

Earnings growth has already been reduced

It’s been hard to accept how stable S&P 500 earnings expectations have been while the market has been volatile and economic data is weakening. Looking underneath the surface there is a different reality. In total seven of the eleven S&P 500 sectors have had estimates reduced. Sectors most sensitive to the interest rate and the economic environment have experienced the sharpest reduction in estimates.

Forecasts have been slashed for the Consumer Discretionary sector. Back in mid-April when companies started reporting first quarter results and giving second quarter guidance, the consensus EPS growth rate for that sector stood at 13%. As of July 6, the consensus expects an 8% decline in EPS year-over-year. The tech- and media-heavy Communication Services sector’s profit forecast has fallen significantly too. The consensus is now expecting a decline in growth of 9.5% compared to a 1.9% decline in mid-April.

Graph titled Q2 Earnings Growth Estimates Have Been Reduced. Interest Rate & Economically Sensitive Sectors Have Been Cut the Most. Compares Q2 EPS estimates from 4/13 and 7/8 for the Consumer Discretionary, Comm. Services, Health Care, Consumer Staples, Technology, Financials, Utilities, S&P 500, Real estate, Industrials, Materials and Energy sectors. Shows earnings/growth estimates have fluctuated for all eleven S&P sectors. As of July 8, 2022, Energy is expected to have the largest growth in Q2 at 242% and Financials will have the greatest decline of -22%. Source: Ally Invest, S&P CapitallQ. Data as of July 8, 2022.

Guidance cuts and stock price reactions

While the second quarter may turn out better than the current thinking expects, the real key to future market movement will be the outlooks companies provide for the remainder of the year. It’s possible that executives will aim to lower the bar given so much macro uncertainty. While that could lead to a reduction in estimates for this year and next, we have already seen some of the cuts get baked in. Consider stocks that threw the kitchen sink into cutting recent guidance, a la Micron and Restoration Hardware, have seen share prices bounce back recently. Sometimes how a stock reacts to news is more important than the news itself.

Looking at guidance trends from companies that have reported in the past month, there has been a greater tendency for companies to raise guidance, rather than cut it according to Bespoke Investment Group. While the spread in the percent of companies raising guidance is declining from the post-COVID boom quarters, it is hardly signaling that corporate outlooks are in significant trouble in the near-term.

Looking ahead, analysts expect S&P 500 EPS to rise by an average of 10% the second half of 2022. For 2023, roughly a 9% earnings increase is anticipated. I would expect CFOs to take advantage of the free pass investors are giving to get more conservative with guidance in the weeks ahead, but in aggregate the total reduction in S&P 500 earnings growth is likely to be less dramatic than the market is anticipating

 Graph titled Companies are Raising Guidance more than Cutting, though Raises Haven’t Kept Pace with Post-COVID Levels. Shows net percentage of companies increasing guidance from June 2020 to June 2022, with fluctuations from 4.4% back down to 3.1% with the net percentage of companies increasing guidance reaching a peak in June 2021 at 28.5%. Source: Ally Invest, Bespoke Investment Group.

Will companies “Buy the Dip”?

It will also be important to watch what corporations do with their capital. Share repurchases are likely to be a cushion for earnings growth. S&P Dow Jones Indices believes buybacks reached a new record in Q2 and will continue to be a favored form of capital deployment for companies. Like consumers, many publicly traded companies are in healthy shape from a balance sheet perspective. Debt as a percentage of GDP remains exceptionally low versus the average of the last 20 years. Margins remain robust and free cash flow is strong. With depressed stock prices compared to just six months ago, companies might look to buy back stock in the coming quarters.

The bottom line

There are plenty of reasons to be cautiously optimistic heading into what could be a volatile Q2 earnings season. Several companies have already cut profit outlooks while others have hinted at the broad economic backdrop being not so bad. With estimates having been reduced in some key sectors and stock prices down big from earlier this year, the bar might be low enough to spark a near-term rally. As 2022 has taught us, however, anything can happen.

Want the Weekly Viewpoint and other market trends delivered to your inbox?

Sign up for Lindsey Bell’s Expert Insights

Expert Take with speech bubble icon

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.

More content from Lindsey Bell.