The earnings recession is here, and it's about to get even worse

Second quarter earnings season begins in earnest this week, and the forecast is rather bleak.

Expectations are for earnings to decline for a third straight quarter. Consensus estimates project a decline of about 7% in earnings per share among S&P 500 companies compared to the same quarter last year, which would mark the steepest decline since 2020, per UBS.

Across the sectors, Consumer Discretionary and Communications Services are the only two of the 11 sectors expected to see second quarter earnings growth materially higher.

Meanwhile, S&P 500 companies are also expected to see no year-over-year revenue growth for the first time in 10 quarters, per Goldman Sachs.

"US economic growth has remained strong since the start of 2Q and explains most of the sales growth in our top-down model," David Kostin, Goldman Sachs chief equity strategist, wrote in a note on July 7. "However, weaker commodity prices and falling inflation, which may limit firms’ pricing power, are incremental headwinds to S&P 500 sales growth."

Thematically, AI buzz will likely get more scrutiny from investors. After AI-led gains last earnings season, Goldman Sachs argues this quarter will be more about if those AI promises are starting to turn into meaningful profits — and when that can be expected. The health of the consumer and the state of the financial system after the spring's banking crisis will also be key themes to watch.

A 'low bar' for earnings

Overall, an earnings decline can still drive upside for stocks if estimates are low enough to begin with. Analysts differ on whether that's the case.

Goldman Sachs and UBS both highlighted a "low bar" for earnings in the second quarter.

Goldman Sachs believes companies will be able to meet it, while UBS sees a less than 1% earnings-per-share miss below that bar.

FILE - A sign for Wall Street hangs in front of the New York Stock Exchange, July 8, 2021. Stocks are opening with slight gains on Wall Street Thursday, Dec. 30, keeping the S&P 500 and the Dow Jones Industrial Average hovering just above the latest record highs they set a day earlier.   (AP Photo/Mark Lennihan, file)
A sign for Wall Street hangs in front of the New York Stock Exchange, July 8, 2021, ahead of second quarter earnings. (AP Photo/Mark Lennihan, file) (ASSOCIATED PRESS)

For its part, Evercore ISI notes some stocks have a lower bar to leap for a beat, but for tech stocks at large, Nvidia's AI surge following last quarter's report sets the bar high.

"Blockbuster 5/24 results from Nvidia have catalyzed upward earnings revisions for the growth heavy Nasdaq," Evercore ISI strategist Julian Emanuel in a weekend client note.

Emanuel also highlighted that last quarter company stocks saw fewer positive reactions to earnings beats in the 24 hours after reporting while companies that missed estimates saw outsized stock reactions to the downside.

There is still a silver lining expected to come in second earnings season. Both Goldman Sachs and UBS use the term "bottom" in their Q2 earnings previews, highlighting the second quarter of 2023 might likely be the worst for year-over-year earnings comparisons.

"Unlike the past 5 quarters, forward earnings revisions appear to have bottomed," Kostin wrote.

Kostin points out that in the long run, S&P 500 returns often follow the forward-looking expectations for earnings.

Prices in the S&P 500 often follow earnings per share revisions, per Goldman Sachs.
Prices in the S&P 500 often follow earnings per share revisions, per Goldman Sachs. (Goldman Sachs Global Investment Research)

Josh is a reporter for Yahoo Finance.

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