Artificial intelligence is sure to be a major player again this earnings season, and looking further ahead, other performers will need to step up too.
On Friday, Wall Street investment banks including JPMorgan Chase, Citi and Wells Fargo are expected to start reporting lackluster second-quarter results. The median analyst estimate suggests U.S. banks' earnings per share fell 10% from a year ago, according to FactSet.
But things should improve from there: The S&P 500 is expected to post an 8.8% gain overall, which would be the best earnings growth since the January-March 2022 period and prove that companies have weathered a period when inflation ate into profit margins.
The actual number will likely be even higher, as management tends to downgrade expectations in order to outperform. As the second quarter progressed, downward revisions to estimates were much less common than usual, and historically, this has also translated into better earnings.
But in a now-familiar pattern, earnings season may not feel as exciting this year, with good news coming from just a few companies as AI craze roils the markets.
In the second quarter, net income for S&P 500 companies that directly benefit from technology is expected to rise 24% compared to the same period in 2023. Of the top 10 companies expected to contribute to profit growth, six are tech giants, including Meta Platforms Inc., Alphabet Inc., Amazon.com Inc., Micron Inc., Microsoft Corp. and AI chip darling Nvidia Corp. The non-AI portion of the index is forecast to report profit growth of just 1.5%.
This highlights an important point: tech stocks aren't just riding a wave of speculation, they're accumulating real wealth from all the investment going into generative AI.
Among the laggards, banks have been big beneficiaries of rising interest rates and are sure to see their profit margins shrink going forward. Other financial companies, such as insurance companies and asset managers, appear to have fared much better in the second quarter.
Profit growth is undoubtedly widespread. In prior quarters, AI companies saw their profits grow at a faster pace, while others saw their profits decline. Of the 11 sectors in the S&P 500, only materials, which includes steelmaker Nucor, is expected to see its earnings fall in the April-June period, while three sectors suffered sales declines in the first quarter.
The catch-up is expected to continue, with “old economy” stocks posting 12% year-over-year net income growth in the fourth quarter, roughly in line with AI beneficiaries, whose growth is expected to slow. Investors can also take some comfort from valuations, with non-AI stocks in the S&P 500 trading at lower price-to-earnings multiples than they were at the end of March, indicating fertile ground for stock picking.
A word of warning: this recovery is fragile. More than half of the companies in the index are expected to report lower profit margins in the second quarter than in the same period last year, with the real estate sector being the hardest hit. Among industrial companies, the airline industry remains a shadow of despair, with the crisis at Boeing and low-cost carriers such as Southwest Airlines hit by rising labor and material costs.
The macroeconomic outlook remains favorable but has become somewhat more uncertain. Recent employment data indicates a slowdown in the U.S. labor market, and consumers appear to be more cautious after the post-pandemic shopping frenzy. The Federal Reserve may respond by cutting interest rates, but it's unclear how much this will help stocks given today's highs. After all, rising borrowing costs haven't weighed much on stocks this year.
AI may be all investors need to stay positive this earnings season, but after that, isolated actions may start to disappoint.
Write to John Sindreu at jon.sindreu@wsj.com.
