By The much-anticipated earnings season for big U.S. banks is set to begin this week. While the overall performance of the S&P 500 may not witness a significant surge based on the second-quarter reports, certain sectors of the market could prove to be more promising.
On Friday, JPMorgan Chase (JPM), Wells Fargo (WFC), and Citigroup (C) are scheduled to report their earnings. Alongside, Delta Air Lines (DAL) and PepsiCo (PEP) will also provide insights into their latest quarterly results earlier in the week. These reports are of great importance as they offer valuable indications of market demand amidst the continued effects of higher interest rates on the economy.
Fortunately, there is positive news indicating that the Federal Reserve might cease its rate hikes soon. The market responded with a slight decline on Friday as it processed the June employment report, resulting in losses for the shortened trading week. The S&P 500 closed down 1.2%, while the Dow Jones Industrial Average experienced a 2% drop and the Nasdaq Composite slipped by 0.9%.
Despite these losses, it is worth noting that since October, the S&P 500 has witnessed a remarkable increase of 23%, making stocks quite expensive. The index’s forward price/earnings multiple over a 12-month period has risen from 15 at the beginning of this rally to 19.2, largely due to substantial gains in several prominent technology stocks.
When considering the current scenario where a risk-free 10-year Treasury offers a 4.1% yield, the high price/earnings ratio of the S&P 500 becomes notable. The earnings yield of the index, based on forward 12-month results, stands at 5.2% – just slightly higher than the Treasury yield. Historically, this additional return is relatively insignificant. Hence, for current stock prices to be justified, earnings would need to surpass expectations by a substantial margin, which appears unlikely.
In conclusion, while the upcoming earnings reports hold significant implications for the market, it is important to be mindful of the existing high valuation of stocks and the need for strong earnings performance to justify these prices.
Reimagining Earnings Season and Investing Opportunities
The S&P 500, which is heavily influenced by the performance of Big Tech, may face challenges if the quarterly numbers of this year’s winners fail to impress investors. With earnings season just beginning, it might be worth considering non-tech stocks as a potentially better investment.
One interesting option is the Invesco S&P 500 Equal Weight exchange-traded fund (RSP). Unlike the capitalization-weighted index, RSP assigns equal weight to each stock, resulting in a more modest 16.6% rally from its fall low. Currently, it trades at about 15 times expected earnings, offering a 20% discount compared to the S&P 500, according to FactSet.
Among the non-tech options, bank stocks appear particularly promising. The SPDR S&P Bank ETF (KBE) has experienced a 21% decline this year and trades for only 7.7 times earnings, which is less than half the multiple of the Invesco fund. Furthermore, industry earnings estimates have dropped by 16% over the past six months due to concerns about loan volumes and lower deal activity, as reported by FactSet. The recent failures of three U.S. banks have also weighed heavily on the sector. However, much of the pessimism seems to be already priced into the stocks, and positive results from the nation’s leading banks could potentially provide a boost.
Thomas Hayes, founder of Great Hill Capital, expresses confidence in the future prospects of banks: “We do think banks are going to get bid in the second half.”
Although it may be unwise to expect earnings season alone to significantly increase the value of the S&P 500, there are certainly opportunities to explore in underperforming sectors. So instead of solely relying on Big Tech, consider diversifying your investments across different industries and seize the potential rewards.
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