Navigating the Earnings Season Amid Market Uncertainties

As the third quarter earnings reporting period approaches, Wall Street is bracing for a complex landscape marked by a mix of growth, caution, and external factors that could shape the market's reaction. With the earnings season set to kick off, investors and analysts are closely watching the performance of the nation's largest banks and the broader implications for the equity markets.

Earnings Season Amid Shifting Tides

Earnings Growth Slows, but Remains Positive

Wall Street projects earnings to grow 4.7% in the upcoming quarter, marking the fifth consecutive quarter of growth since the same period a year prior. However, this would also represent the slowest year-over-year growth since the fourth quarter of 2023, signaling a potential moderation in the pace of earnings expansion.The deceleration in earnings growth comes as stocks have charged higher than normal between reporting periods, leading some strategists to anticipate a muted market reaction. Deutsche Bank's chief equity strategist, Binky Chadha, notes that "earnings seasons are typically positive for equities, but the strong rally and above-average positioning going in argue for a muted market reaction."

Macro Factors Take Center Stage

Alongside the earnings landscape, a growing list of external factors is expected to capture investor attention over the next month. Rising tensions in the Middle East have sent commodity prices soaring, adding to the economic uncertainty. The looming presidential election is also anticipated to contribute to market volatility, as investors grapple with the potential implications for the economy and policy.Moreover, the current trajectory of the economy and the Federal Reserve's interest rate decisions remain heavily debated, further complicating the investment landscape. Evercore ISI's Julian Emanuel emphasizes that the "Macro, and its very uncertain uncertainties, [will] continue to exaggerate over Micro this earnings season."

Election Years and Earnings Seasons

Historically, earnings seasons in election years have not typically led to further upside in the near term for stocks. Emanuel's analysis of the past four election cycles dating back to 2008 reveals that the S&P 500 has experienced negative returns in October during these periods."Earnings seasons during election years have seen stocks react less than normal to their sales [and earnings per share] results, an indication of the overhanging Election's implication for equities," Emanuel wrote in a note to clients.

The High Bar for Earnings Beats

Despite the potential headwinds, strategists believe there could be positive catalysts from this earnings season and takeaways for investors to consider going forward. Citi's equity strategist, Scott Chronert, notes that the earnings backdrop entering the reporting period is set up for better-than-typical beats compared to Wall Street's estimates and less-than-usual cuts to forecasts.However, Chronert cautions that "the bar is high," as index multiples are at top decile levels, and the implicit growth framework leaves little room for missteps. He warns that this setup "does not necessarily scream 'sell,' but historically, have come with volatile market action, to the up and downside."

Improving Earnings Breadth

Entering the reporting period, 72% of companies are expected to grow earnings year over year, the highest proportion since the fourth quarter of 2021. Bank of America Securities' US and Canada equity strategist, Ohsung Kwon, sees this as a potential sign that "breadth continues to improve."Kwon believes this earnings season will be crucial in understanding how companies are navigating the lower interest rate environment and what their outlook for the future holds. "Now that the easing cycle has started, what are companies … going to say about any early indications of improvement given the lower rate environment?" Kwon said.As the earnings season unfolds, investors will be closely watching for insights into the broader economic landscape, the impact of external factors, and the ability of companies to navigate the evolving market conditions. The coming weeks will be a crucial test for the resilience of the equity markets and the strength of the corporate earnings narrative.