As Wall Street entered the final stretch of the second-quarter earnings season, U.S. markets began the week on a relatively calm note after enduring a period of heightened volatility driven by mounting recession fears. The past few weeks have been particularly turbulent, marked by significant swings in the stock market as investors navigated a complex landscape shaped by mixed economic data and global monetary policy developments.
Typically, the earnings season—when America’s largest companies report their financial results—sees increased trading activity as investors react to corporate performance and forward guidance. However, this quarter has been anything but typical. The last month, and especially the past two weeks, have been characterized by abnormal market volatility, with investors reacting sharply to a variety of economic indicators and geopolitical events. Last week, in particular, saw volatility levels spike to their highest point since the early days of the COVID-19 pandemic, triggered by a combination of a weaker-than-expected jobs report and an unexpected rate hike from the Bank of Japan. These factors, coupled with ongoing political uncertainties, have cast a shadow over the outlook for U.S. equities, despite what has largely been a positive earnings season.
Corporate Profits: Resilience Amid Uncertainty
Despite the challenging economic backdrop, corporate profits have displayed surprising resilience. As of Monday, the S&P 500 was on track to report earnings growth of 10.8% for the quarter. If this figure holds, it would represent the index’s strongest earnings growth since the fourth quarter of 2021, when companies were benefiting from the tailwinds of a post-pandemic economic recovery. Additionally, the proportion of companies that have beaten earnings estimates—78%—is slightly above both the 5-year (77%) and 10-year (74%) averages, indicating that corporate America has managed to perform well even in the face of economic headwinds.
However, a closer look reveals some underlying softness. While the percentage of companies beating earnings estimates is encouraging, the magnitude of these beats has been relatively modest. On average, companies have exceeded earnings expectations by just 3.5%, which is significantly lower than the 8.6% average seen over the past five years. This suggests that while the top-line earnings figures may look strong, there are still challenges beneath the surface, such as cost pressures and margin compression, that companies are grappling with.
Revenue Growth: Slowing Amid Cautious Spending
While corporate earnings have held up well, revenue growth has been less impressive, reflecting a more cautious approach to spending by both consumers and businesses. The S&P 500 is projected to report revenue growth of 5.2% for the quarter, which is below the 5-year average of 6.7%. Moreover, the percentage of companies reporting better-than-expected revenue is also below the 5-year average, indicating that top-line growth is becoming harder to achieve in the current economic environment.
This slowdown in revenue growth can be attributed to several factors, including inflationary pressures and a more cost-conscious consumer base. As inflation continues to erode purchasing power, consumers and businesses alike have been reining in spending, which has squeezed the top lines of many companies. However, the impact has not been uniform across sectors. For example, the fast-casual restaurant chain Shake Shack (SHAK) reported its second consecutive quarter of double-digit revenue growth, while its competitor, McDonald’s (MCD), experienced a decline in same-store sales. Analysts suggest that this disparity may be due in part to the narrowing price gap between traditional fast-food chains and fast-casual restaurants like Shake Shack, Chipotle (CMG), and Sweetgreen (SG), which may have shifted consumer preferences.
Big Tech’s AI Investments: A Double-Edged Sword
In the technology sector, major companies have been significantly ramping up their investments in artificial intelligence (AI), a move that has sparked mixed reactions from investors. During the quarter, Alphabet (GOOGL) and Microsoft (MSFT) dramatically increased their capital expenditures (CapEx), with much of this spending directed towards AI-related infrastructure, such as semiconductors and data centers. Alphabet’s CapEx rose by 91%, while Microsoft’s jumped by 55%, underscoring the intensity of the AI arms race among Big Tech companies.
Despite the long-term potential of these investments, the immediate costs have raised concerns on Wall Street. The high level of spending has spooked some investors, leading to significant declines in the stock prices of the so-called “Magnificent Seven” tech giants during the period when most of these companies reported their earnings. The market’s reaction suggests that while investors recognize the importance of AI for the future, they are also wary of the short-term financial impact of such heavy investments, especially in an uncertain economic environment.
All eyes are now on Nvidia (NVDA), a key player in the AI space, as it prepares to report its earnings on August 28. Nvidia has been a major beneficiary of the AI boom, particularly as cloud service providers have ramped up their spending on AI hardware. The company has enjoyed four consecutive quarters of triple-digit revenue growth, and expectations are sky-high heading into its next earnings report. However, Nvidia’s stock remains vulnerable to any signs of weakening demand or delays in its next-generation Blackwell chips, which could significantly impact investor sentiment.
Financial Sector: At the Crossroads of Interest Rates
The financial sector has also been a standout performer this earnings season, reporting the third-largest increase in earnings among all sectors. Profits in the financial sector grew by 17.6% compared to the same quarter last year, with all five sub-industries—Insurance, Capital Markets, Consumer Finance, Financial Services, and Banks—posting earnings growth. Initially, elevated interest rates provided a boost to big banks, as the interest they earned on loans increased. However, as deposit costs have risen, net interest income—a key profitability metric—has come under pressure, leading to a more challenging environment for banks.
Now, with the Federal Reserve signaling the possibility of cutting interest rates from their current multi-decade highs, the financial sector is approaching a critical juncture. Lower interest rates could once again expand banks’ interest margins, as deposit costs typically decline faster than the income generated from fixed-rate loans. Additionally, a rate cut could spur a pick-up in loan demand, providing a much-needed boost to the sector. Moreover, cash-strapped consumers, who have been grappling with rising credit card delinquency rates, might find some relief in a lower interest rate environment, potentially reducing the risk of defaults and further stabilizing the financial sector.
Looking Ahead: Navigating an Uncertain Landscape
As the second-quarter earnings season winds down, investors are left to grapple with a complex and uncertain landscape. While corporate profits have shown resilience, the broader economic environment remains challenging, with inflation, slowing growth, and geopolitical uncertainties all weighing on sentiment. As companies provide guidance for the remainder of the year, the market will be closely watching for signs of how they plan to navigate these challenges.
Investors will also be paying close attention to upcoming economic data releases and central bank actions, which could have significant implications for market direction in the coming months. The Federal Reserve’s next moves, in particular, will be closely scrutinized, as any shifts in monetary policy could either provide a tailwind or pose additional headwinds for the market.
In summary, the second-quarter earnings season has offered a mixed bag of results, with strong corporate profits offset by slower revenue growth and rising costs. As the market moves forward, the focus will increasingly shift to how companies and policymakers respond to the evolving economic landscape, and whether the resilience shown so far can be sustained in the face of mounting challenges.