Third-quarter earnings downgrades have been substantial across major regions, with ongoing reductions noted in both the U.S. and Eurozone, according to JPMorgan strategists. These downgrades reflect increasing worries about slowing top-line growth and macroeconomic uncertainty.
In a note released on Monday, the Wall Street firm stated that the earnings outlook for S&P 500 companies has been significantly revised downward, indicating that the threshold for surprises has decreased for Q3.
Despite this lowered benchmark, the overall forecast for year-over-year EPS growth in Q3 has dropped from 8% a few months ago to just 4%. Notably, the EPS estimate for companies excluding the Magnificent 7—the largest tech stocks—now stands at only 1.4%, a sharp decline from the previous quarter’s 5% growth rate.
“The gap between the Magnificent 7 and the rest of S&P 500 earnings growth is likely to continue narrowing,” the note states.
While the Magnificent 7 have driven S&P 500 earnings over the past year, their growth is now slowing. JPMorgan anticipates these companies will see a 17% year-over-year earnings increase in Q3, which is half of what was recorded in Q2 and one-third of the projected growth for Q4 2023.
In terms of sector performance, downgrades are mainly concentrated in cyclical sectors, particularly Commodities, Industrials, and Consumer Discretionary. Financials is the only cyclical sector showing positive performance, while defensive sectors like Utilities and Real Estate are performing better, according to JPMorgan strategists.
Regionally, European earnings have experienced even more pronounced cuts than those in the U.S., with Q3 EPS growth forecasts in the Eurozone shifting from 4% growth to a 2% contraction.
Key drivers of this underperformance include Energy and Autos, while in the U.S., the growth spread between cyclical and defensive sectors remains minimal, with both showing growth rates around 0-4%.
The report also raises concerns about future earnings, as global PMI data shows signs of weakening and suggests that the slowdown may persist, leading to further earnings downgrades.
JPMorgan notes that Brent crude, a key global oil pricing benchmark, is typically “strongly positively correlated with sales growth,” indicating potential downside
“Profit margins at the index level are above historical averages in both the U.S. and Europe, and they could remain so unless there’s a deterioration in the mix,” the firm added.
Additionally, over 40 U.S. and European companies have already issued profit warnings ahead of the reporting season, with European stocks averaging a 10% drop on the day these warnings were announced.
Overall, JPMorgan cautions that while expectations have been adjusted downward, there’s no certainty that the results will generate a positive market response. The bank stresses that with 2024 EPS projections at their lowest in both the U.S. and Europe, “EPS revisions need to improve to support P/E multiples”.
“The historical correlation between P/E and EPS has been clearly positive, but that gap is widening,” it stated.
Strategists maintain a cautious view on sectors such as Chemicals, Luxury, Industrials, Autos, Semiconductors, and Mining, highlighting weak earnings revisions and a potentially soft Q3 reporting season, suggesting that the recent rebound in cyclical sectors could lose steam.
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