As the second quarter earnings season kicks off, Wells Fargo (NYSE:WFC) analysts caution that consensus expectations may be overly optimistic.
The bank states that historically, 65% to 70% of companies beat earnings expectations, but this rate has risen to 75% to 80% in several quarters since the pandemic.
According to Wells Fargo, this consistent outperformance can be attributed to companies' conservative guidance strategies. "Many companies avoid being overly aggressive on revenue and profit estimates as they would rather 'under promise and over deliver,'" the analysts note. However, the current economic climate presents unique challenges.
"Transition times in the economic cycle can be tricky for economists and CFOs," Wells Fargo points out, suggesting that the potential for earnings surprises, both positive and negative, increases during periods of economic slowdown or rebound.
The consensus estimate for the second quarter, according to Bloomberg data, predicts an 8.1% year-over-year growth rate for the S&P 500 Index (SPX).
This optimistic outlook persists even as the economy shows signs of slowing. Wells Fargo highlights that earnings growth has been concentrated in a small number of tech and tech-related companies, which have also driven the bulk of SPX gains this year. In contrast, broad earnings strength has been lacking.
Wells Fargo underscores this point by noting that four out of eleven S&P sectors are expected to report negative year-over-year earnings results for the second quarter. In the first quarter, three sectors experienced earnings contractions greater than 20% compared to the previous year. "This is not a scenario where the rising tide is lifting all boats," the analysts observe.
Ultimately, Wells Fargo advises a cautious approach. "We think consensus expectations might be a bit optimistic," they state, recommending more conservative positioning and anticipating increased market volatility, which they believe will present investment opportunities in the coming quarters.