Third-quarter earnings are upon us. So are worries of slower growth.

By Bill Peters

'The kind of religion these companies have gotten on costs, is here to stay,' analyst says

This summer, restaurants and many retailers who weren't Walmart warned of a struggling consumer. Doubts grew over the artificial-intelligence ambitions of big tech, whose size alone propels much of the stock market, and the AI bandwagon overall. And after signs of a slowing job market, the Federal Reserve cut interest rates to stimulate the economy. But that, for some, raised questions about the state of an economy that needed stimulation in the first place.

When companies start to report third-quarter earnings this week, led by JPMorgan Chase & Co. (JPM) and Delta Air Lines Inc. (DAL), we'll see how much more prodding the economy needs before the worrying dissipates.

"The major things that moved the markets, that got us the most phone calls and questions, were certainly this obsession with the Fed and the interest rate cuts," Mark Malek, chief investment officer at the financial services firm Siebert, said of the broader trends that defined the quarter.

He added: "Overtaking that by the end of the quarter was the fear of the economy falling into a recession. They go hand in hand with each other."

Squashing those fears might not be easy. Many of the concerns that defined the last wave of quarterly results are present for this one.

Ahead of the results, analysts continued to talk about the "bifurcation" among consumers - between the higher-income ones more insulated from the past two years of price hikes and lower-income ones who have felt the pain more acutely. There are deepening worries over the widening war in the Middle East, the war in Ukraine and the upcoming U.S. election. The impact of China's monetary stimulus plans, intended to steady its faltering economy, is not yet clear.

Analysts say it could take time for the benefits of lower interest rates to filter into everyday life. And they continue to debate whether the Fed needs to make borrowing costs even lower to make that happen, and how much investors, after piling into big tech companies like Nvidia Corp. and Microsoft Corp., might seek gains elsewhere.

Still, markets were upbeat about the U.S. September's jobs report. And a dockworkers strike at East Coast ports that threatened to snarl the economy has been suspended until Jan. 15 following a tentative agreement with their employers.

Slower growth for Q3

For the companies in the S&P 500 index, Wall Street analysts expect earnings per share growth of 4.2% in the third quarter, according to a FactSet report released Friday. That would be the fifth straight quarter of per-share profit growth year over year, but a slowdown from the second quarter and the first quarter, as well as the third quarter of 2023.

That report also said that Wall Street analysts cut their third-quarter earnings-per-share projections more than average in a sign of lower expectations. But lower expectations, in turn, can make it easier for companies to top them.

Even as inflation eases, people are still feeling the pinch from higher-priced groceries and some services, as well as cost cuts at their jobs. However, corporate profit margins overall are set to be more-or-less fine. Net profit margins for S&P 500 companies are expected to come in at 12.1% for the third quarter, according to the FactSet report.

That margin forecast is close to the historic heights seen in 2021. And while it's down slightly from the prior quarter, it's above the five-year average of 11.5%, the report said.

That 12.1% estimate - driven in no small part by price increases, layoffs and budget tightening - is likely to come down as more quarterly results come in. But it also reflects a bigger priority for controlling expenses, after the prior decade's bull market.

"The discipline companies have been showing over the last few years, and the kind of religion these companies have gotten on costs, is here to stay," said John Belton, managing director for growth portfolios at Gabelli Funds. "And I think that technology is going to continue to be a big enabler of margin expansion profitability moving forward."

Lower interest rates are likely to have a clearer impact on the real estate industry. But some analysts have said mortgage rates wouldn't ease immediately, and that they could still push home prices higher as buyers try to take advantage of lower borrowing costs.

John Workman, managing director of investment strategy at Pathstone, said that since the Fed cut interest rates so late in the third quarter, the bigger impact would be in the fourth quarter and beyond. But he noted that the Fed would also try to remain flexible.

"So I think we do have to take those cuts with a grain of salt," he said.

Banks, big tech

For JPMorgan (JPM) and the other big banks, the results, as always, will offer a broader look at the lending and spending that drives the economy. Analysts will be watching for any outlook on the market for loans, IPOs and deal-making as rates come down, following more caution from corporate clients.

In the weeks that follow, we'll start to hear from the so-called Magnificent Seven - Facebook parent Meta Platforms Inc. (META), Google parent Alphabet Inc. (GOOGL), AI chipmaker Nvidia Corp. (NVDA), Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN) and Tesla Inc. (TSLA) Those results will arrive as those companies invest heavily in AI, raising questions about the cost of the technology, its ability to live up to lofty expectations, and the timing of an eventual payoff.

When asked in July about its AI spending, Sundar Pichai, Alphabet's chief executive, said "the risk of underinvesting is dramatically greater than the risk of overinvesting for us," given the technology's potential to transform how things get done.

But a report from Goldman Sachs last month issued a note of caution to AI investors. That report said that historically, when new technology emerges, investors "over-focus on the originators" while underestimating the potential for new companies "that can piggyback off the capex of others, enabling them to generate new products and services."

"I think the discussion or the debate in the market became a little bit more two-sided," Belton said. "I guess I would characterize the market as becoming a little bit more fatigued on the AI theme."

He added later: "The two-sided debate ... stems from this bearish view that there's almost a prisoner's dilemma in the market right now, and companies are feeling like they're being forced to invest hand over fist in this technology despite lack of revenues being generated on the other side."

As lower interest rates take the pressure off other companies, investors could direct their attention accordingly. But analysts say there's still plenty in the tank for the Magnificent Seven.

"We think there's still a lot of growth for these companies, but other companies are also going to be growing as well," said Brad Peterson, national portfolio advisor at Northern Trust. "So investors are going to be broadening their exposure."

The call to put on your calendar

JPMorgan Chase: JPMorgan reports quarterly results on Friday. Chief Executive Jamie Dimon, as usual, will likely offer some broad thoughts on the global economy. Otherwise, much of the focus seems likely to be on the impact of lower interest rates, which might rejuvenate borrowing and business expansion but shave a little off how much banks profit from each loan.

Analysts could also zero in on how trading operations at JPMorgan and its peers fared, following speculation on how many times the Fed would cut rates this year, as well as swings in the stock market. But as a MarketWatch story noted on Friday, the big U.S. banks get a smaller slice of their revenue from loans than smaller regional banks, potentially limiting the gains from lower rates.

Wells Fargo & Co. (WFC) also reports on Friday.

The numbers to watch

Delta, Pepsi sales: Before 2020, airline investors routinely fussed over the industry's ability to prop up fare prices - and sales - by keeping seat availability tight, and they fretted over how much money airlines could squeeze out of each passenger. Those issues got thrown out the window when the pandemic hit. But this July, they came back, sort of, after Delta Air Lines (DAL) said that the industry's supply of available seats on domestic flights had "accelerated" through the summer, with each additional seat diluting the money Delta could make off passengers in the main cabin.

Management said travel demand was still strong. And they said Delta, which draws a lot of its profits from more premium-class fares anyway, was more insulated than its rivals from all of these issues. When Delta reports quarterly results on Thursday, Wall Street will see how much.

Elsewhere, PepsiCo Inc. (PEP) - the company behind Pepsi, Mountain Dew, Fritos and Doritos - reports results on Tuesday. The drinks-and-snacks giant will report as concern grows about consolidation in the food industry, and how much it might restrict competition and give the bigger players more power to raise snack prices on shoppers.

Higher grocery prices have become a bigger political topic this U.S. election season. But with the S&P 500 Index up more than 20% so far this year, the gap between consumer sentiment, election sentiment and market sentiment remains.

"At the macro level, we really think it's all about economic growth and earnings, and that's looking good right now," Peterson said. "And I think that's why the markets have shrugged off election anxiety."

-Bill Peters

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10-06-24 1001ET

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