Corporate America earnings may have reached the bottom

by Natalia Kniazhevich

Corporate America is sending an important signal this earnings season that the rally in US stocks can continue to broaden out beyond technology shares.

Cyclical companies, whose prospects are closely tied to the trajectory of the economy, are still citing sluggish demand, according to Bank of America Corp.’s analysis of results through last week. The announcements over that period cover 36% of the S&P 500 Index’s earnings, according to the bank.

Yet in an important forward-looking signal, the mention of a “bottom” in the results through last week, which had a heavy weighting toward cyclical companies, is up 56% from a year earlier, Bank of America says. That’s significant because history shows that an increase in such references tends to point to an improvement in earnings, the bank said.

It would be a bullish development for investors worried about the dominance of technology shares in the stock market that goes from one record to the next this year, especially with the megacap companies projected to show slowing profit growth, on average. Results from those behemoths are set to start rolling in after Tuesday’s close, when Alphabet Inc. is due to report.

“We feel like third-quarter earnings for a lot of cyclical companies represent a bottom,” said Joe Gilbert, a portfolio manager at Integrity Asset Management. “This does not mean, however, that we are off to the races with earnings estimates going higher, but it does give us confidence that the environment is not going to get worse.”

It’s been a tough stretch for cyclical sectors, which have had to grapple with feeble demand and higher inventories after the Federal Reserve boosted interests rates to the highest in decades to quell inflation. With the central bank easing and the economy in solid shape, the outlook for these companies is brightening. 

“Companies have been operating in a weak demand environment for almost two years now due to the weakness in goods/manufacturing,” Bank of America strategists wrote in an Oct. 28 report. “But we see signs that the worst may be behind us.”

For next year, they wrote, “we expect a healthy volume recovery in manufacturing/goods sectors that have been pressured by higher rates, which should translate to upside” in earnings per share.

US manufacturing activity shrank in September for a sixth month, reflecting weak orders and declining employment. However, on a more promising note, a Dallas Fed manufacturing survey suggests that the October ISM is likely to tick up, wrote Chris Collins at Bloomberg Economics.

So far, third-quarter earnings season across industrials and materials has shown year-over-year declines and the number of companies that posted weaker-than-expected results hit the highest level since 2017, according to Wendy Soong, an equity strategy data analyst at Bloomberg Intelligence.

And there are plenty of risks for cyclicals ahead, such as uncertainty around the US presidential election and questions around the pace of China’s economic recovery.

But there have been some bright spots. 3M Co., the maker of Post-it notes and Scotch tape, increased the low end of its 2024 profit forecast and reported third-quarter earnings that topped analyst estimates. Fastenal Co., which sells industrial and construction supplies, showed sales improving in the quarter, according to Bloomberg Intelligence.

Some companies from the materials sector, which depends on the global commodities cycle, have posted positive results, too. Strong aluminum prices boosted Alcoa Corp.’s quarterly earnings.

Copyright Bloomberg News