Two big earnings trends as we end the first half of the year and look forward to the second half: 1) Aggregate estimates for the S & P 500 are slightly higher than the start of the year, indicating the analyst community as a whole is not modelling a recession into earnings estimates, at least not yet. 2) Much of the profit rise this year is due to the oceans of money going into the coffers of oil companies. Which is it: a soft landing or a recession? That’s the key to earnings in the second half You might have heard that Wall Street seems to be divided on the central issue for the markets: Will the Fed induce a recession, or will there be a soft landing? One thing everyone seems to agree on: If a recession is imminent, there will be another leg down in the market. Oddly, that division over whether there will be a recession or a soft landing does not seem to be shared by analysts. S & P earnings estimates have increased steadily through 2022. It was expected to be up about 8% on January 1, and is now expected up about 10% compared to 2021, according to Refinitiv. In a recession, earnings always decline, usually at least 20 percent. The fact that earnings expectations are expected to be up 10% this year (and another 10% in 2023) indicates that analysts are pricing in no chance of a recession. In one sense, this is not surprising. “Wall Street analysts have always been too optimistic on future earnings,” Nicholas Colas from DataTrek said in a recent note to clients. A more nuanced picture: It’s oil, stupid It’s tempting to say, “The analysts are idiots,” but it’s not that simple. The aggregate earnings picture is being grossly distorted by the explosion in profits from oil companies. Energy is far and away the big profit winner in 2022. You will rarely see a sector that is now expected to see profit gains of 120% in a year, but that is what is happening if you own an oil company. Energy: The big earnings winner in 2022 January 1: up 28.4% Today: up 120.5% Source: Refinitiv All the big oil companies are seeing a huge expansion of profits: Oil companies: 2022 profits exploding (estimates) ExxonMobil up 92% Occidental Petroleum up 313% Chevron up 109% ConocoPhillips up 150% EOG up 93% Source: Refinitiv This is what is dragging the aggregate earnings estimates for the S & P higher. Not surprisingly, Energy is the best performer of the 11 S & P sectors this year, up 5% while the S & P is down 20%. Consumer Discretionary and Communication Services are lagging At the same time, two larger sectors tied to the consumer are seeing their estimates go lower, led by consumer discretionary. Consumer Discretionary: 2022 earnings (estimates) January 1: up 28.5% Today: up 3.2% However, a good part of the decline is due to two companies, Amazon and Starbucks. Other retailers (Home Depot, Lowe’s) are expected to see their earnings increase, as are most home builders like Lennar and Pulte. Communication Services are also seeing a decline in earnings expectations, led by Netflix and Meta (Facebook). However, other stocks in this sector, such as Walt Disney, are seeing earnings estimates higher. Communication Services: 2022 earnings (estimates) January 1: up 6.9% Today: down 4.6% Not surprisingly, Consumer Discretionary and Communication Services are the two biggest losing sectors in the S & P this year, down 30% and 28% respectively. So which is it: soft landing or recession? Keith Lerner, chief market strategist at Truist Advisory Services, neatly summarized the current consensus on earnings: “It’s become a growing consensus on Wall Street that earnings, which have held up remarkably well this year, are the next shoe to drop in the market. The thinking behind this view is that the first part of the market decline was a reset in valuations from elevated levels, which has largely played out. Now, the next leg of the market decline will come from the effects of a slowing economy trickling down into earnings.” While Lerner does not necessarily think stock prices are in for a 20% additional drop, he did note that a 20% decline in earnings would be typical for a recession. Not surprisingly, expectations that earnings will rise in 2022 are a little too much for many on Wall Street. “Given all the Fed is trying to accomplish, and at a quick tempo, that seems like an aggressive assumption,” Nick Colas said. It is especially optimistic given that corporate America is now experiencing some compression in profit margins due to higher costs, according to Ben Snider at Goldman Sachs: “While investors are focused on the possibility of recession, the equity market does not appear to be fully reflecting the downside risks to earnings,” he wrote in a note to clients. Even on Wednesday, General Mills and McCormick cited higher costs than expected in the quarterly earnings report. Snider says that will become more common: “Assuming no change in expected revenues, the margin compression we model would reduce the median stock’s expected 2023 EPS growth from +10% to 0%.” And that is for 2023. Analysts are still expecting 10% growth for 2022. Better pray for that soft landing.