Sector ETFs Turn Focus To Earnings Slowdown

Corporate earnings growth is expected to have decelerated during the first quarter.

The first quarter earnings season swung into high gear this week, giving investors an opportunity to refocus on the micro after broader macroeconomic factors dominated the headlines for much of this year.  

So far, profits have been a mixed bag based on the flashiest reports. Netflix cratered nearly 40% after its report, while Tesla spiked as much as 10% after its release. But outside of those headline-grabbing moves, things have been more consistent. 

According to data from FactSet, of the companies in the S&P 500 that have reported so far, 77% have beaten their earnings-per-share estimates, while 80% have beaten their revenue estimates.  

That’s the good news. The much more middling news is that the rate of growth in earnings in Q1 compared with the same period a year ago has only been 5.1%—the slowest pace since the fourth quarter of 2020.  

Part of the reason for that is earnings growth was so strong in Q1 of last year—more than 50%. But profit margins are also expected to tick down for a third-straight quarter, pressured by rising expenses.  

The year-over-year earnings comparisons get easier as the year goes on, and profit margins are anticipated to rebound. That’s why analysts are forecasting overall 2022 EPS growth to be more than 10%. 

As usual, that growth won’t be even across sectors. The energy sector is expected to grow its profits at the fastest rate, followed by industrials. Utilities, financials and consumer staples are expected to see the slowest growth, both in Q1 and in 2022 as a whole. In fact, profits at financial firms this year may actually decline, if analyst estimates are correct. 

Earnings/Price Relationship 

Earnings are the lifeblood of the equity market. Long term, the ultimate driver of share prices is cold hard profit. 

However, short term, that relationship doesn’t always hold. Multiples—the amount investors are willing to pay for a given amount of earnings—can go up and down significantly for all sorts of reasons, and their movement often overwhelms any change in profits. 

This year, energy is by far the best-performing sector in the stock market, with a 42% gain for the Energy Select Sector SPDR Fund (XLE). But while energy stocks have responded to the rise in energy profits, the same can’t be said for other sectors. 

For instance, the information technology sector is down more than 15% this year despite an anticipated 12% growth in earnings for the sector. Similarly, profits for consumer discretionary companies are forecast to rise nearly 18% this year, but the sector is lower by 12%. 

There are a number of reasons stock performance might disconnect from earnings growth in the short term. Perhaps the growth is already priced in; or investors don’t anticipate the growth to last; or they just aren’t willing to pay for the growth due to various factors. 

In the case of high-growth technology stocks, rising interest rates have reduced the value of future earnings, dampening the multiples that investors are willing to ascribe to those businesses.  

So, yes, over the long term, earnings are the primary driver of stocks, but that says nothing about the short term. 

*Estimates

Follow Sumit Roy on Twitter @sumitroy2