Investing.com -- Third-quarter earnings downgrades have been significant across major regions, with persistent cuts in both the U.S. and Eurozone, JPMorgan strategists said, reflecting growing concerns about slowing topline growth and macro uncertainty.
In a note published Monday, the Wall Street firm said the earnings outlook for S&P 500 companies has been substantially lowered. It notes that "the hurdle rate has come down for Q3, suggesting the bar for surprises is lower."
However, even with this reduced hurdle, the overall expectation for year-over-year EPS growth in Q3 has been cut from 8% a few months ago to just 4%.
Particularly noteworthy is the fact that the EPS forecast for companies excluding the Magnificent 7, the largest tech stocks, stands at a mere 1.4%, marking a sharp slowdown compared to the previous quarter’s 5% growth rate.
“The differential between Mag-7 and the rest of S&P500 earnings growth is likely to continue narrowing,” the note writes.
The Magnificent 7 companies have been a strong driver of S&P 500 earnings in the past year, but is now slowing. JPMorgan expects the group’s earnings to grow 17% year-over-year in Q3, half of what was seen in Q2 and a third of Q4 2023 growth.
In terms of sector performance, the downgrades are mainly concentrated in cyclical sectors, especially Commodities, Industrials, and Consumer discretionary. Meanwhile, Financials is the only selector among Cyclicals that is in the green, while defensive sectors like Utilities and Real estate “are holding up better,” JPMorgan strategists said.
Regionally, European earnings have faced even more significant cuts than in the U.S. For the Eurozone, Q3 EPS growth projections have shifted from 4% growth to a 2% contraction.
Energy and autos are cited as key drivers of this underperformance, while in the U.S., the spread between cyclical and defensive sectors remains minimal, with both hovering around 0-4% growth.
The report also raises concerns about future earnings. With global PMI data losing steam and indications that the topline deceleration will continue, the potential for further earnings downgrades looms.
JPMorgan explains that Brent, a major global benchmark used for pricing oil, is generally “strongly positively correlated with sales growth, and is pointing to downside.”
“Profit margins at index level are above past averages, in both the US and in Europe. They could stay so, barring some mix deterioration,” the firm added.
Furthermore, the report notes that over 40 U.S. and European companies have already issued profit warnings ahead of the reporting season. The average stock reaction to these warnings has been severe, with European stocks dropping an average of 10% on the day of the announcement.
Overall, JPMorgan warns that while expectations have been lowered, there is no guarantee that results will spark a positive market reaction. The bank emphasizes that with 2024 EPS projections sitting at a year low in both the US and in Europe, “EPS revisions really need to turn up in order to support P/E multiples.”
“The P/E vs EPS correlation was historically clearly positive, and the gap is opening up,” it said.
Strategists maintain a cautious outlook on sectors such as Chemicals, Luxury, Industrials, Autos, Semiconductors, and Mining. They highlight weak earnings revisions and a potentially soft Q3 reporting season, suggesting that the recent rebound in Cyclicals could lose momentum.
They also believe sector leadership may shift back to trends seen over the summer and recommend considering cyclical investments only after the Q4 earnings season.