Q2 earnings season preview: Key watchpoints for markets

On the latest edition of Market Week in Review, Director of Client Investment Strategies, Mark Eibel, and Research Analyst Emily Zhao discussed the ongoing tug-of-war in markets, the outlook for second-quarter earnings season and key investor watchpoints over the next few months.

Inflation likely to remain key focus for markets.

Zhao noted how US markets have generally been directionless over the past week, alternating between rallies and selloffs - sometimes on a daily basis. Eibel said this could emerge as the theme of the summer as markets struggle to process whether skyrocketing inflation has peaked or not.

A classic example of this, he said, occurred on 24 June and 30 June. On 24 June, following the release of several PMI surveys that indicated economic growth may be cooling, the Dow Jones Industrial Average and the S&P 500® Index both climbed roughly 3% on the idea that inflation may have peaked, Eibel noted. "Then, on 30 June, the Fed’s preferred gauge for inflation-the personal consumption expenditures (PCE) price index-showed that inflation isn’t improving much. In response, markets immediately sold off," he observed.

In Eibel’s opinion, this back-and-forth in markets between inflation fears, rising interest rates and recession worries will probably persist until a real catalyst - besides prices being cheaper than they were at the start of the year - emerges. "I wouldn’t be surprised if this give-and-take, so to speak, that we’re seeing in US markets on a daily basis continues through much of July and August," he stated.

What to expect during Q2 earnings season

Zhao and Eibel shifted the conversation to US second-quarter earnings season, with Eibel remarking that the upcoming season is likely to be very interesting now that the period of easy comparables is over. "By this, I mean that the timeframe when corporate earnings in 2021 were compared to corporate earnings in 2020 is now in the past," he said, explaining that comparisons to 2020, when the economy was largely shut down, helped make 2021 earnings growth phenomenal. Now, S&P 500 companies are entering a period where comparisons will be harder, he explained, as corporate earnings from an open economy in 2022 are measured against corporate earnings from an open economy in 2021.

In addition, Eibel expects that it will be harder for companies to hit their earnings growth targets, as businesses will have greater difficulty passing along price increases to consumers. "Consumers are reaching the point where they can’t take much more in the way of price increases," he noted. In addition, many businesses improved efficiencies during COVID-19, but are unlikely to become even more efficient moving forward, Eibel added.

He said that in addition to the earnings themselves, forward guidance and commentary from companies will be a critical watchpoint during second-quarter earnings season. "This could, potentially, be a real mover for markets in the next month or so, as markets have largely gone down so far due to price, and not earnings. But if earnings and guidance really take a hit, we could see US markets decline further," Eibel stated.

Other potential market drivers: US employment report, Q2 GDP and Russia-Ukraine war

Zhao and Eibel wrapped up the segment with a look at other key watchpoints for investors over the next few months. The US consumer price index (CPI) reading for June, due out in mid-July, will be one of them, Eibel said, especially since May’s CPI reading came in unexpectedly higher. In addition, the US June employment report will be closely watched, he noted, as well as the country’s second-quarter GDP (gross domestic product) growth rate. "Remember, first-quarter GDP declined by 1.6%, so if the second-quarter number comes in negative as well, that would mean the US is technically in a recession," he remarked.

Investors will also be paying close attention to geopolitical issues, including the Western response to the Russia-Ukraine conflict, as well as the status of China’s economic reopening, Eibel said. "A full reopening of China would help ease supply-chain snarls and satisfy global demand for goods," he noted. Ultimately, with no shortage of hot-button issues for investors to focus on, Eibel expects the summer season in the Northern Hemisphere to be an interesting one for markets.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.