Earnings season kicks off as US banks and Tesla dominate

Earnings season lookahead

The third quarter US earnings season is upon us, with companies throughout the country reporting for the July to September period.

During the midst of a historic battle against inflation, investors and traders will be paying close attention to see if businesses are truly feeling the pinch under the weight of elevated interest rates. Borrowing has become increasingly expensive as a result, with expectations of a higher-for-longer approach at the Fed causing additional tightening of financial conditions thanks to rising long-term yields. 

Markets are anticipating a fourth straight quarter of year-on-year earnings declines for the S&P 500, with -0.3% expected in Q3 2023. Once again, we are expecting to see the energy and commodity names drive that weakness, reflecting the decline seen in crude from mid-2022 to the June 2023 low. On the positive side, the introduction of AI seems to have helped boost the outlook for earnings, with big tech falling into the communication services sector – which is predicted to enjoy a 31% bump in annual earnings. Will tech manage to keep up with lofty expectations? Will the recent crude rally help energy names outperform as outlook overshadows historical earnings?

Big banks dominate first weeks

Financial stocks look to dominate the first two weeks, with over 40% of the S&P 500 companies reporting over the first fortnight coming from the sector. Earnings season appears to really get going on the Friday, when JP Morgan Chase, Citi Group, Black Rock, and Wells Fargo look to kick start proceedings.

With banks in focus, traders will be looking for updates across a number of crucial aspects. Firstly, the obvious element is whether we could see an increase in loan loss provisions as the impact of higher interest rates begin to take a grip on the economy. As seen below, there’s an expectation that we will see the top banks announce their worst bad loan write-offs since the second quarter of 2020. With inflation having seen much of the Covid savings having been spent, there’s also a feeling that we will soon see pressure on businesses and consumers that will come to the detriment of high-street banks.

While rising rates can bring greater margins for bank loans, there is a fine line given the risk that rising interest rates will ultimately drive economic weakness. Housing market concerns will similarly provide a focus for those banks reliant on significant mortgage books, with volumes likely to decrease as demand eases in response to affordability concerns. There is similar uncertainty ahead for investment banking, with trading income likely to be volatile amid a mixed period for markets in Q3. Will we see a shift towards fixed income as economic concerns build to the detriment of equities?

With all this uncertainty, there is a hope that the banks will manage to outperform simply due to low expectations. However, a strong start on Friday could be a poisoned chalice for those banks reporting next week, with markets typically pricing in anticipation of a similar experience across the board.

Price cuts and weak deliveries dent Tesla hopes

Week two looks set to be headlined by automotive giant Tesla, with recent delivery data providing a warning for shareholders. Planned factory shutdowns saw Tesla deliver 7% less vehicles in Q3 (435,059), although that figure is still an impressive 26% higher than last year. While the company expects strong production in the fourth quarter, there are concerns that we are going to see earnings impacted. Alongside weaker output, Tesla have had to slash their pricing in the US and China over recent few quarters, denting profit margins.

However, despite markets expecting to see earnings weaken this quarter, there is an argument that any weakness could provide a buying opportunity. Firstly, fact that markets are pricing in a EPS decline could set Tesla up for a positive beat, with each of its part eight reports seeing EPS above estimates. It is also notable that the company has managed to gradually improve the return on the capital they invest (ROIC). The rapid rise over recent years has seen the company move into a strong position despite short-term economic headwinds. While the market capitalisation of Tesla may make it seem as though they are hugely overvalued compared to their peers, the company’s move into profitability over recent years has managed to drive down debt and turn the company into a cash cow. Their strong ROIC figure means that they are able to drop prices over the near-term to beat off competition, but remain highly profitable. However, for now markets will be keenly watching to see how lower margins and a weaker delivery figures impact earnings or revenues.