US Q2 earnings season – what to expect?

The US Q2 earnings season is now under way, bringing with it an onslaught of new information to digest and analyse.

For our team, it’s an opportunity to update our models and retest the investment case for each one of our holdings, as well as to take the measure of the economy as a whole. Q1 results were generally positive for our holdings, with strength in areas we would consider ‘early cycle’ such as housing and transport. We are hoping for more of the same this quarter.

Ahead of the earnings season, bottom-up forecasts were revised down, as is typically the case. However, they have only been revised down in line with historic norms, rather than in the previous three quarters when sell-side analysts aggressively cut their estimates to reflect economic uncertainty and margin pressure.

The market remains extremely bifurcated. There are plenty of examples of companies where earnings and margins are going through recession-like conditions. Yet there are others that are still seeing extraordinary levels of demand and profitability. Along with the rest of the market, we will be watching closely to see how companies have coped with the economic uncertainty and whether they have been able to pass on higher prices to protect margins.

Below, we summarise what we are looking out for across the US market as well as our expectations for key holdings:

Technology | Will Warren

Tech stocks have rallied in recent months on enthusiasm over AI and signs that inflation is peaking. Overall, we think only a few companies are likely to beat expectations on earnings and would not be surprised to see share prices fall back. Another measure we will look out for is mentions of AI. In Q1 earnings transcripts, 110 of the S&P 500 companies mentioned AI¹ . We expect it to be closer to 500 this time.

We originally bought Meta as a contrarian turnaround story. We now think the near-term recovery is well understood but the durability of the core business and opportunities for new growth are underestimated. Although the major benefits of headcount reduction and cost cutting have been seen, we expect continued spending discipline will mean Meta will beat consensus earnings expectations for the rest of this year. Over the medium to long term, we think investors will begin to appreciate that Meta’s significant incremental investment in AI and datacentre infrastructure will lead to meaningful new markets and product categories. We expect Alphabet (which we do not hold) to report a strong quarter but continue to prefer Meta for the reasons outlined above.

The semiconductor sector has risen strongly since Nvidia’s blow-out Q1 results. While we believe there is long-term AI opportunity for the sector, we do not expect it to affect near-term numbers for any company other than Nvidia (which we hold) and so expect the sector may weaken through the earnings season. We remain bullish on semiconductors, especially the capital equipment segment, and would be looking to add to positions on weakness. Nvidia reports at the end of August and remains a core holding.

In software, we hold Microsoft and Oracle. Much of the Microsoft story is now well understood by investors – its ability to raise prices across most of its products remains its key differentiator compared with other software companies. We would expect Q2 earnings to narrowly beat expectations, but the real opportunity in Microsoft over the longer term is in AI. We also believe investors do not fully appreciate the new trajectory of growth in Oracle and its opportunity in the public cloud market. On Apple, we recognise that it is a fantastic technology franchise, but struggle with its valuation and so have an underweight position.

Industrials / materials | Chris Kent

Heading into the earnings season, negative company updates have been primarily in the chemicals sector, where demand remains very weak as customers continue to destock. For this reason, we don’t hold any commodity chemical stocks. We do own speciality chemical company Linde, which we regard as a defensive business.

In transportation, we own SAIA and TFI International trucking companies. We think that their second-quarter results will mark the trough in volumes. We also own CSX, a rail operator, where we think meaningful improvements in service will result in better-than-expected earnings for the second quarter.

Housing starts have been better than expected recently and we think this should be supportive for our holdings in Builders FirstSource and Eagle Materials. The latter, along with Vulcan Materials, should also benefit from healthy demand for heavy construction materials.

Healthcare | Olivia Micklem

The healthcare sector has lagged the market so far this year. Sentiment has been very negative towards the health insurers and many of the life science companies. Medical device and hospital-related stocks have fared better since patient attendance picked up after Covid.

We recently bought Steris. It runs sterilisation departments for hospitals and medical device manufacturers, so should benefit from the acceleration in procedures following the pandemic. We like the long-term growth opportunity in the sector, with a high mix of recurring revenues and a strong competitive moat.

We also own Dexcomm, a diabetes business with glucose-monitoring technology. We would expect to see positive comments from the company this quarter as it updates the market on the launch of a new platform.

Consumer cyclicals | James Dudgeon

We have a cautious outlook on this sector. The excess savings built up in the pandemic are being run down, especially among lower- and middle-income consumers. Student loan repayments (paused during the pandemic) will start up again in September. We are avoiding classic retail stocks and are focused on discount retailers (such as Burlington) that benefit from consumers trading down.

The funds are overweight Amazon for three reasons. First, the retail business continues to take market share and we expect profits to pick up this year after a huge build-out of logistics that dampened margins. Second, AWS (the cloud business) is in a cyclical slowdown which should see much easier comparisons in the second half of the year, while the structural growth outlook remains attractive. Finally, Amazon’s valuation remains at the bottom end of historical ranges.

Financials | Zuoyi Zhou

The worst of the banking crisis seems to be behind us, but the sector will be closely watched for any signs of stress. Given the known structural issues facing both retail and commercial real estate, the market will be monitoring any rise in losses or provisions. Mortgage rates remain stubbornly high, but this does not seem to have dampened the housing market recovery, due to low levels of inventory.

We remain underweight financials, with limited exposure to banks. Our focus is on more idiosyncratic names within the sector such as Intercontinental Exchange, Visa and Moody’s.