- Wall Street has set a low bar for Q3 earnings, Bank of America says.
Earnings season is kicking off this week and companies should expect to be rewarded as long as they express optimism about lower interest rates.
That's according to Bank of America, which notes that apart from that dynamic, the bar for third-quarter earnings set by Wall Street is pretty low.
The analysts expect 2% earnings growth, below consensus estimates of 4% and second-quarter earnings growth of 11%.
The second quarter's mild beat, coupled with a slowing macro environment, has lowered investors' expectations going into this earnings season, the analysts say.
"The bar isn't high. As long as companies have managed through macro headwinds and see early signs of improvement from lower rates, stocks should get rewarded," the analysts said in a Tuesday note.
They say consensus estimates have already priced in weakness, with earnings-per-share estimates cut by 4% for the quarter, which makes an earnings beat more likely amid lower rates.
The Federal Reserve cut interest rates by 50 basis points at the end of the third quarter, sending the S&P 500 to record highs as markets began pricing in the coming interest-rate easing cycle.
Lower rates will spark a rebound for the most rate-sensitive sectors, like manufacturing and housing, which were most impacted by the Fed's previous hiking cycle, the analysts said.
The ISM Manufacturing Purchasing Managers Index posted its second-longest downturn in history in the last two years, and existing home sales fell almost 40% from a year ago, showing clear signs of a downturn amid high rates.
The analysts recommend watching those sectors for early signs of improvement from lower rates ahead of earnings.
"Many say the hiking cycle didn't have much impact on the economy, which is 70% services/consumption. However, rate-sensitive sectors (e.g. manufacturing and housing) have certainly been hurt by the Fed's actions," the analysts said.
"But now that an easing cycle has officially started, we expect a healthy recovery in manufacturing and housing activity, boosting earnings growth for the S&P 500 into 2025," they added.
So far, 62% of the 21 companies that have already reported third-quarter earnings topped both earnings-per-share and sales estimates, compared to 49% historically and 47% last quarter, the analysts say.
While stocks are set to continue posting mild earnings beats this quarter, the analysts say the focus isn't on the present quarter — it's on the outlook for future quarters amid Fed easing.
They expect the market rally to broaden out into the next year, with the Magnificent Seven set for slower earnings growth in the third quarter. Growth in the other 493 stocks in the benchmark index should accelerate to double-digit growth beginning in the fourth quarter.
"Although Mag. 7 earnings are still expected to outpace Other 493 earnings, we expect the narrowing growth differential should be a big driver of the market broadening out, given the extreme valuation and positioning gap," the analysts said.