Analysis-Expected rise in US earnings could be balm for stocks after rough stretch

By Caroline Valetkevitch and Lewis Krauskopf

NEW YORK (Reuters) - A resilient economy and strong consumer demand are expected to fuel a slight rise in third-quarter U.S. earnings, which could throw a lifeline to a stock rally that has stumbled in recent months.

S&P 500 companies overall are expected to have increased earnings by 1.3% from a year ago, according to LSEG IBES. Though tepid, it would mark a pickup after three quarters of flat or declining profits.

Some investors believe that could boost a deflated U.S. stock market. The S&P 500 is down roughly 6% from its late-July highs, though still up about 12% year-to-date.

After a rough September for stocks, "we need some good news" from earnings season, said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.

"You've had a rate shock, you've had a confidence shock," Miskin said. "The economy has held up okay, but you need to see it come through in the numbers to support equities."

Inflation dampened company earnings in the first half, after consumer prices surged in 2022 to their highest levels in decades. Some market participants believe comparatively robust economic growth could make the third quarter a turning point.

Friday's monthly U.S. jobs report for September was the latest evidence of economic strength. Employment rose by the most in eight months, suggesting consumer demand could stay intact for now.

"The economy has remained relatively strong and companies - particularly the largest companies - were in a good position to pass on some price increases and keep margins fairly strong," said Rick Meckler, partner at family investment office Cherry Lane Investments.

COMPETITION FROM BONDS

Worries over rising interest rates and the likelihood that the Federal Reserve could keep rates high for longer left all three major U.S. stock indexes with losses for September and for the latest quarter.

Treasury yields have surged to 16-year highs, dulling the allure of stocks by offering investors comparatively high income on risk-free government bonds.

Even after recent declines, the S&P 500 index is trading at nearly 18 times forward 12-month earnings estimates, exceeding its long-term average of 15.6 times, according to LSEG data.

Investors will watch for signs that higher rates have raised costs for companies, slowing their ability to borrow and grow.

"If earnings are slipping here and interest rates have gone up and growth looks a bit weaker ...I think you are going to see some pretty big earnings revisions to the downside," said Miskin, of John Hancock.

Earnings kick off on Friday with J.P. Morgan Chase and other major U.S. banks. The bulk of earnings reports are due in late October and early November. Other companies due to report this week are Delta Air Lines, PepsiCo and UnitedHealth Group

"If the banks set the tone pretty well … that could be good for the market," said James Ragan, director of wealth management research at D.A. Davidson.

EYES ON TECH

Artificial intelligence is likely to be a key theme again. Investors will look to see if companies can turn optimism over AI developments into an improved outlook. "We know companies are investing a lot," Ragan said. "Are they going to start to talk about the business case?" Analysts expect technology sector earnings to have risen 6.0% in the third quarter, and see earnings for the communication services sector up 33.8% - the most of any sector, based on LSEG data. Investors will also scrutinize company fourth-quarter outlooks, with S&P 500 earnings for the fourth quarter currently expected to rise 10.8% from a year earlier.

While the economy has defied expectations for a downturn this year, some investors expect cracks could appear as rate hikes start to bite. The Fed has raised benchmark overnight rates by 525 basis points since March 2022.One clue could come from the consumer discretionary sector, where earnings are expected to have jumped by 23.1% from the year-ago period. "If you truly expect there to be a recession around the corner, you'd probably be cutting back on discretionary goods first,” said Oliver Pursche, senior vice president and advisor for Wealthspire Advisors in Westport, Connecticut.

(Reporting by Caroline Valetkevitch and Lewis Krauskopf; editing by Megan Davies, Ira Iosebashvili and David Gregorio)