The US stock market is touching new highs. So far, the three major indexes have earned tremendous returns this year. Is the market rally justified? Corporate earnings are at the lowest level this year. The first-quarter earnings season was disappointing. Now, we’re heading into the second-quarter earnings season. We might be heading into an “earnings recession.”

Is an ‘Earnings Recession’ on the Horizon?

As of July 12, the S&P 500 Index has risen 20.2% YTD (year-to-date). The tech-heavy NASDAQ Index has risen 24.2%, while the Dow Jones has risen 17.1% YTD, respectively.

Overall, the markets started the year on a good note. The three major indexes rose. However, the markets faced challenges in May. President Trump reignited the US-China trade tensions. The market bounced back again. Investors are optimistic about a rate cut at the FOMC meeting in July.

What’s in store in the second quarter?

On July 12, a FactSet report mentioned that around 88 S&P 500 companies have negative profit warnings for the second quarter. For the second quarter, the S&P 500’s lower estimated earnings are -3.0%. According to CNBC, trade escalations and sluggish economic growth could take a toll on the second-quarter earnings.

Is an ‘Earnings Recession’ on the Horizon?

As of July 12, 24 of the S&P 500 companies reported their second-quarter earnings. Many of the companies said that foreign exchange hurt their second-quarter earnings and revenues. According to CNBC, Bank of America’s equity and quant strategist, Savita Subramanian, discussed the earnings season in a client note. Subramanian said that this earnings season could reveal how the trade war impacts corporate profits.

Clouds are looming 

According to FactSet, most of the sectors could see a decline in their second-quarter earnings. Overall, trade tensions continued. The trade tensions have taken a toll on various companies’ corporate profits—especially companies with exposure in the Chinese market. President Trump’s meeting with Chinese government officials at the G20 summit didn’t provide much relief. However, both of the countries agreed to wait on new tariffs and proceed with negotiations, which CNBC reported last month. Global economic growth also is a concern.

Is an ‘Earnings Recession’ on the Horizon?

Materials sector could report the highest decline 

In the second quarter, about six sectors will likely report a year-over-year decline in their earnings. The materials sector has the most significant exposure to China. The materials sector is projected to report the highest earnings drop of 16.6%, according to FactSet. The metals and mining, chemicals and containers, and packaging subsectors could contribute to the decline. Freeport-McMoRan (FCX) and DuPont de Nemours (DD) are expected to report the highest earnings drops in the sector. Freeport-McMoRan and DuPont de Nemours are scheduled to report their second-quarter earnings on July 24 and August 1, respectively. The materials sector reported an 11.6% decline in its first-quarter earnings, according to Factset.

IT sector could report a loss

The IT sector is expected to report a decline of 11.9% in its second-quarter earnings. Semiconductor and technology hardware might lead the decline. According to FactSet, Micron Technology (MU) is expected to be the most significant contributor to the lower earnings. The technology sector reported a 6.6% decline in its first-quarter earnings based on a Factset report.

Other sectors

The consumer sector started the year on a good note. The job numbers implied more employment and higher consumer spending. However, the escalating trade war took a toll on the consumer sector. Many consumer companies earn a substantial portion of their revenues from China. So, the consumer staples sector’s earnings growth could decline by 3.0%. The consumer discretionary sector is expected to report lower earnings growth of 3.4%.

While these sectors are expected to decline, defensive sectors like health care and utilities will likely have earnings growth of 2.1% and 1.7% respectively. Notably, the real estate sector has been soaring this year. The sector is also expected to show earnings growth of 1.1%.

Markets’ performance last week

Last week, the markets rose after Fed Chair Jerome Powell testified before Congress. He hinted at a rate cut in July. Powell mentioned that business investment across the US slowed down, which impacts the overall economy. The SPDR Dow Jones Industrial Average ETF (DIA) tracks the Dow Industrial Average Index. DIA closed with a gain of 1.5% last week. DIA has returned 17.2% YTD. The Invesco QQQ Trust (QQQ) tracks the NASDAQ Composite Index. QQQ has gained 25.4% YTD. The ETF closed with a gain of 1.3% last week. The SPDR S&P 500 ETF (SPY) tracks the S&P 500 Index. SPY closed with an increase of 0.73% last week. SPY has returned 20.3% YTD.

What to expect this week 

Many companies will report their second-quarter earnings this week. J.P. Morgan, Goldman Sachs, Wells Fargo, Bank of America, Microsoft, Netflix, eBay, United Airlines, Johnson & Johnson, Dominos’ Pizza, and Morgan Stanley are scheduled to report their earnings this week. Investors need to see how the second quarter turns out for these companies. We’ll have to wait and see how the stock market reacts to this “earnings recession.”

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