‘Make-or-break quarter’ on Wall Street as earnings roll in

NEW YORK (AP) — Crunch time is coming to Wall Street.

Throughout this gilded year for investors, growth has kept accelerating for all kinds of forces that boost stock prices, sending the S&P 500 to more than 40 records. Now, though, investors are preparing for life on the downward slope of the mountain.

The economy is still growing, to be sure, but at a slower pace. The same is likely to become true soon for support from the Federal Reserve. But the crunch of a post-peak world will become most quickly apparent in coming weeks as companies report how much profit they made during the summer.

The forecast for this earnings season would be considered a very healthy one in normal times. Analysts are looking for S&P 500 companies to report earnings per share that are nearly 28% higher for July through September than they were a year earlier.

That would be the third-fastest earnings growth since 2010, according to FactSet. But it would also mark a sharp slowdown from the second quarter’s 90.9% profit surge, when the economy was exploding out of the crevasse created by coronavirus shutdowns.

“We’ve seen the peak, it’s pretty clear, and now we’re beginning to decelerate right at the time that monetary and fiscal policy support may be waning,” said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments.

Crucially, that deceleration is happening just as strong corporate profit growth is becoming a more important support for stock prices.

A stock’s price generally rises for a couple possible reasons: Either the company is making more in profit, or investors are willing to pay more for each $1 of those profits. Lately, that second possible reason has been going in reverse as longer-term interest rates rise.

The yield on the 10-year Treasury note has climbed to roughly 1.60% from about 0.75% a year ago and from 1.20% three months ago. Stubbornly high inflation has been one reason, along with expectations that the Fed will soon announce a paring back of its immense bond-buying program.

When interest rates are rising and super-safe bonds are paying more in interest, investors feel less need to pay such high prices for stocks. They’re now paying about $20.60 for each $1 in earnings per share expected from S&P 500 companies in the coming 12 months. That’s down from a price tag that topped $24 a little more than a year ago.

For stock prices to keep rising past their recent peaks, or even just to maintain their current levels, strong corporate earnings growth will have to do more of the lifting.

During the third quarter, the entirety of the S&P 500’s 0.2% rise was due to increased expectations for corporate earnings, according to Credit Suisse strategists. If profit forecasts hadn’t risen as much as they did, the S&P 500 would have fallen to its first quarterly loss in a year and a half.

Analysts routinely undershoot reality, with earnings beating their forecasts in all but two of the last 50 quarters. But Savita Subramanian, a strategist at Bank of America, expects earnings this reporting season only to be roughly in line with expectations. An unusually high number of companies have warned that their results may fall short of expectations, she noted. Perhaps more worrisome is that she expects analysts to trim their 2022 profit forecasts after they hear from CEOs during their earnings reports.

Among the challenges hitting corporate profits: supply chain problems around the world and a renewed summertime surge of COVID-19 that slowed the economy. Wages and fuel costs are also rising, adding inflationary pressure and eroding companies’ profitability. Worries about a slowdown in China’s economy, the world’s second-largest, are also hitting revenue expectations.

That’s part of the reason why Subramanian in a recent BofA Global Research report called this earnings reporting season “the make-or-break quarter.”

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