Wall Street has plenty to digest this week , with a slew of economic data that could offer clues on whether the U.S. is set to tip into a recession. It’s also a big earnings week, with more than 150 S & P 500 names set to report by Friday. “With inflation raging, the Fed aggressively hiking interest rates, economic momentum slowing, and recession risks rising, we think the Q2 corporate earnings reporting season is of heightened importance,” said RBC Wealth Management in a note last week. “Earnings news in the coming days and weeks could shape the market’s near-term path and provide hints about prospects for profit growth over the medium term,” RBC analyst Kelly Bogdanova said. Here’s what Wall Street banks are watching for as markets continue to assess how sharp an economic slowdown could be. Margin pressures Analysts say they will be watching this headwind on companies, with higher costs that may squeeze companies more than anticipated. In the United States and Europe, there’s a widening gap between earnings per share numbers and sales beats to below average levels. That implies many firms are facing growing margin pressures, Barclays said in a July 22 note. “While mentions of supply chain issues have moderated a bit compared to prior quarters, mentions of cost headwinds from raw materials, labour and energy inflation remain elevated,” Barclays analysts wrote. Still, some companies may be able to maintain pricing power, said RBC. “For example, PepsiCo reported that it has successfully passed along price increases to customers,” RBC wrote. “But we think other companies will fail to keep pace with higher input and wage costs. We expect margin pressures to cause some high-profile earnings misses and negative guidance.” Earnings distortions Investors need to look more deeply at individual sector contributions to overall index earnings to “better understand how recession risk may play into the earnings picture,” Citi analysts, led by Scott Chronert, wrote in a July 22 note. Citi said the financials sector, which is a “materially higher” contributor, is set to drive 15% of 2023 index earnings relative to its 11% market cap weight. It therefore holds an important key to the earnings outlook, the bank said. Citi expects financial sector earnings to be fairly resilient into next year — relative to recession concerns — on the back of higher rates. Still, the sector is becoming a drag on the overall S & P 500 index, RBC said in a July 21 note. Excluding financials, the S & P 500 index is on pace for earnings growth of 13.8%, but if financials are included, the overall earnings growth drops to 5.7%, RBC said. Energy is another area to watch. Citi said that while its market cap is at just 4% of the index, the sector is expected to drive 10% of index earnings this year as earnings jump on higher oil prices. If oil prices fall, next year’s contribution is set to be closer to 8%, said the bank. “While the overall S & P 500 earnings growth rate is pacing at 5.7 percent, if the Energy sector is excluded the rate drops to -2.5 percent,” RBC added. Dollar headwinds The U.S. dollar has surged more than 10% since the start of this year, and that’s set to hurt earnings, analysts said. Goldman Sachs said dollar strength suggests “many firms would miss 2Q revenue estimates,” with 29% of S & P 500 revenues from outside the United States. A 10% appreciation in the trade-weighted dollar could reduce earnings per share by as much as 2% to 3%, it said in a July 22 note. Coca-Cola said that currency headwinds worked out to be a 6 percentage point hit on its revenue this quarter, up from 3 percentage points in the last quarter. 3M said this headwind resulted in a 4 percentage point decline on second-quarter sales, according to a FactSet earnings transcript. Evercore ISI projected in a July 26 note that IT hardware and industrial tech companies would feel a larger revenue hit from the stronger dollar, versus 90 days ago. A few such firms, Apple , Dell , HP and NetApp , may suffer a 100 to 150 basis point hit to their revenues, according to Evercore.
