Early on in earnings season, companies’ profits are surpassing expectations, but the stock market remains unaffected. This is significant because the market’s response to earnings reports can provide valuable insight for investors. If a stock doesn’t show significant growth or even falls after a company announces higher-than-expected profits, it often indicates that the stock was already priced high, taking into account the anticipation of strong profitability in the future.

Despite positive earnings reports, there are various other factors that can influence stock prices. Therefore, investors might choose to wait for a more affordable price before making any investment decisions. Nevertheless, the second-quarter results have presented an optimistic outlook for U.S. companies.

Impressive Second-Quarter Results

As of Tuesday morning, companies representing approximately 8% of the S&P 500’s market capitalization have disclosed their profits for the quarter. Over 75% of these companies have reported higher earnings per share (EPS) than expected, exceeding estimates by about 11%. Sales have also surpassed expectations by just under 2%, indicating healthier profit margins than anticipated.

Financial and Nonfinancial Sectors Outperform

The financial sector has been leading the way, with companies such as JPMorgan Chase (ticker: JPM) reporting surprisingly strong results. Higher interest rates have increased lending profitability, while consumers’ financial stability has enabled them to manage their debts effectively. Consequently, the financial sector has exceeded EPS expectations by approximately 17%.

In addition to financial companies, nonfinancial sectors have also contributed significantly to the positive earnings trend. Consumer discretionary and technology companies have exceeded forecasts by double-digit percentages, while industrial companies’ earnings have beaten expectations by around 5%.

Despite the initial lackluster response in the stock market, the impressive earnings results suggest a promising outlook for both financial and nonfinancial sectors in the coming months. Investors should closely monitor these developments and consider the potential opportunities they present.

Strong Demand and Lowered Profit Estimates

Despite the efforts of the Federal Reserve to slow the economy, there is still strong demand for goods and services. However, Wall Street has also played a role in supporting the economy. Prior to the disclosure of earnings results, analysts had lowered their profit estimates. As a result, companies had a lower bar to hurdle. The aggregate forecast for profits from S&P 500 companies had fallen by about 4% from March through just before the earnings season.

Impact on Stock Prices

The earnings results, however, have not provided a significant boost to stocks. On average, the stock-price reaction for companies reporting higher-than-expected sales and EPS has been a gain of 0.2%, compared to the historical average of about 1%. On the other hand, stocks of companies that fell short of forecasts saw an average decline of 4.1%, while the five-year average drop is 2.9%.

Tech Stocks Driving Market Surge

Not only are the stocks of reporting companies experiencing stagnant growth, but the overall market surge of the S&P 500 has been largely driven by tech stocks with enormous market capitalizations. While the S&P 500 has surged by 18% in 2023, the Invesco S&P 500 Equal Weight ETF (RSP), which provides equal weighting to each stock in the index and eliminates the outsize effect of Big Tech, has remained flat since Thursday, prior to the start of earnings season.

Expensive Stock Valuations

One reason for this stagnant growth is that most stocks were already fairly expensive before the earnings season commenced. The equal-weighted S&P 500 is trading at nearly 16 times the per-share earnings that its component companies are expected to generate in the next 12 months. This is an increase from just over 14 times at the beginning of the year.

Heavy Lifting Required for Rally

While profit reports have been strong so far, the expensive stock valuations are not ideal for sustained stock market gains. In order to keep the rally going, earnings need to perform exceptionally well. Jeffrey Buchbinder, the chief equity strategist at LPL Financial, emphasized the need for earnings to do “heavy lifting” to support further gains.

In summary, while stocks have the potential to continue rallying, it is unlikely that this earnings season will provide significant fuel for further market gains.

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