The Q2 Earnings Season Could Be A Bloodbath

Revlon Puts The Fear Of Bankruptcy Into The Market 

If the latest news from Revlon (NYSE: REV) is any indication of what to expect from the Q2 earnings reporting season we just got really scared. We’ve been worried about the season for a number of reasons that all come down to earnings. In the case of Revlon, competition and rising cost pressures forced the company to decline a voluntary Chapter 11 bankruptcy, a move intended to let it reorganize itself for the new operational environment. The takeaway is the problems facing Revlon are being felt throughout the market and, while we don’t expect to see a trend of Chapter 11s develop, we are not expecting to hear much good news at all, especially from the weaker players. Extrapolating this to other businesses, industries, and sectors, those laden with debt or using debt to fuel growth are about to have a reckoning. 

“The filing will enable the company to strategically reorganize its legacy capital structure and improve its long-term outlook amidst challenges like supply chain disruption and rising inflation and obligations to its lenders.”

The Estimates For Q2 Are Falling, But A Bottom May Be In Sight 

The outlook for Q2 earnings are trending lower and will likely move to near 0.0% by the start of the reporting session. Nearly half of the S&P 500 (NYSEARCA: SPY) sectors have a consensus figure that is not only negative but in decline and, of the 6 left, 2 more are sitting at sub-5% growth and trending lower as well. The leader, in terms of downward revision, is the Consumer Discretionary Sector (NYSEARCA: XLY) which has seen its consensus target fall nearly 2200 basis points since the beginning of the reporting period. Of all the sectors, the Consumer Discretionary is most at risk of following in the tracks of Revlon although debt-heavy tech stocks and anything with the word growth attached to it are in danger as well. 

On the flip side, there are four sectors that are seeing positive tailwinds in the analyst's revisions. The Energy (NYSEARCA: XLE), Real Estate (NYSEARCA: XLRE), Materials (NYSEARCA: XLB), and Industrials (NYSEARCA: XLI) sectors are expected to post growth and their targets are moving higher. In this light, these sectors should be expected to outperform the broad market and with Energy in the lead. The Energy Sector is still doing all the heavy lifting, however, when it comes to the S&P 500 consensus figures as it is expected to post 207% YOY earnings growth, up a full 6000 basis points in just the last 2 months. Of them all, the Energy Sector is the best positioned to outperform (based on current oil price action) as well as increase dividends, buy back shares, and other capital-returning activities. 

The Back-Half Estimates Are On The Rise 

Oddly enough, the estimates for the back half of the year have begun to rise. There are enough rays of light, we suppose, for this to make sense but we’re not ready to buy into the news yet. To begin, the Q2 season is still ahead of us and it may be worse than we fear. In this scenario, the market will move lower before it bottoms and our targets are still well below the current price action. To finish, the back half improvement is predicated upon supply chain improvements that may lead to bloated inventories, discounting, and margin compression. In that scenario, the S&P 500 may bottom during the Q2 reporting period but it will be a temporary bottom. In both cases, there will be a better time to buy the market than today. 

The Technical Outlook: The S&P 500 Should Hit 3,400 Soon 

Anyone who denies the S&P 500 is in a full reversal either doesn’t understand technical analysts or is lying to themselves and others. The S&P 500 confirmed its reversal in the early week of June and is now on track to hit the 3,400 level. The post-FOMC meeting sell-off is a continuation of a near-term downdraft and that should shave 350 points off of the index. This puts the index down at another key support level that, if broken, opens the door and ushers the bears down toward the 2,800 level. If the 2nd quarter results are better than expected and/or come with brightening guidance we see a bottom at 3,400. If not, this market will erase all of the COVID bump and maybe a bit more.