Investing.com -- The third-quarter earnings season kicks off, and despite recent downward revisions to expectations, the S&P 500 (SPX) continues to reach record highs.
However, strategists at Wells Fargo (NYSE:WFC) caution that the overall market may not offer much excitement, as the likelihood of significant earnings beats or misses for the SPX at this stage in the cycle is low.
Earnings season typically garners significant media attention, but Wells Fargo believes investors must realize that in an environment of moderating growth and easing inflationary pressures, most companies are unlikely to report results that deviate substantially from their prior guidance.
“As the economy gradually slows, most individual company analysts have an easier time confirming the guidance their companies are giving out when it comes to revenues and earnings,” the bank’s strategists note.
“Sure, there will be the usual big positive and negative surprises coming from a relatively small number of individual companies, but not so much from the overall market,” they added.
Predicting earnings becomes particularly difficult when the economy experiences sudden changes in direction, but under current conditions, companies and analysts should be better aligned.
The strategists also suggest that companies are less likely to issue bold or optimistic guidance in an uncertain economic environment, even if their outlooks are positive. Still, Wells Fargo expects 2024 to be a record year for SPX earnings, with further gains projected into 2025.
They also emphasize that earnings reports are backward-looking. Earnings "merely tell the story of what happened in the past — and really just the very recent past," they explain.
For this earnings season, they see the process as more of a confirmation of the broader economic outlook.
“We see third-quarter earnings confirming that our outlook for the economy has been correct; the economy is in a slowing trend that is nearing its end,” strategists said.
Looking ahead, Wells Fargo is focused on the future economic recovery, which they expect to continue developing through 2025. They believe cyclical sectors, such as Industrials, Financials, and Materials, will benefit most from an upswing. The Energy sector is rated as their top pick, while they also favor Communication Services.
In sum, Wells Fargo strategists advise investors not to get caught up in the earnings season hype, stressing that earnings reports are a lagging indicator. Instead, they recommend focusing on future economic trends and the sectors poised to benefit from them.