The second quarter reporting season is off to a great start, and it looks as if the worst of the profit recession is behind us, that’s the key takeaway of a new equity market research report from Deutsche Bank published at the end of last week.

It looks as if the worst of the profit recession is behind us

Deutsche’s figures show that the second quarter earnings season is off to a great start. 40% of companies in the S&P 500 have reported earnings and the average earnings per share beat is 5% or 5.6% excluding financials.

Analyst Expect S&P 500 Earnings to Sink for Q3

Big banks including JP Morgan, Citigroup, Bank of America and Goldman Sachs all beat on good trading, decent loan growth, more cost-cutting and less litigation expense, which surprised many analysts. Big tech also produced a solid set of results with Microsoft and IBM both beating on earnings and revenue.

Soaring Dollar Is Yet Another Risk To Earnings Growth

For the second quarter reporting season as a whole, Deutsche now expects the S&P 500 to report average earnings per share of $29.50 compared to earnings per share of $27 reported for Q1. If earnings hit this target, S&P 500 EPS will be up 1% compared to the year-ago period and up 10% quarter-on-quarter.

It looks as if the worst of the profit recession is behind us
It looks as if the worst of the profit recession is behind us

However, while the second quarter reporting season has surprised to the upside, Deutsche points out that there are many risks to earnings growth in the second half. For the full year, Deutsche was targeting earnings per share of $127 for the S&P 500, based on an average oil price of $50 to $55 per barrel, a steady dollar, and stable interest rates. But after recent events the bank has revised down its bottom-up 2016 S&P 500 EPS forecast to $118 .83 after analysts lowered Energy and Financials profits by 10% and 4% respectively on lower oil prices and falling rates.

How should investors react 

So, what does this all mean for investors? Well based on the above forecast Deutsche Bank has a year-end S&P 500 target of 2,150. This estimate is based on a P/E multiple of 18.25 time estimated 2016 earnings per share.

Does Trading Volume Increase Or Decrease Prior To Earnings Announcements?

Still, as mentioned above there are plenty of risks to earnings during the second half of the year, and while Deutsche believes that lower yields could support a higher S&P 500 earnings multiple, the bank isn’t rushing to upgrade its forecast just yet. As strategist David Bianco and team explain in the report:

“Our year-end S&P target remains 2150, which is 18.25x our $118 2016E EPS. Current yields, if sustained, would support a higher trailing PE on normalized S&P EPS, however, we resist raising our target PE until: 1) the Fed hikes again, as we want to see if long-term yields stay this low despite another hike, 2) S&P EPS y/y growth is 5% or better, as this pace of growth is required to support a steady-state PE (1/real Ke). It’s unclear if S&P EPS growth will be 5%+ in 2017, given dollar and oil risks upon a hike and the pressure to bank EPS if long-term yields do stay this low. Furthermore, the cycle continues to age, warranting some caution on the PE, and while non-GAAP EPS has improved, $10 or more should be deducted from non-GAAP S&P EPS before capitalizing for valuation.”

And while the analysts are cautiously optimistic about the outlook for the S&P 500, they offer a word of warning stating that “we think another 5-9%+ dip before the election is likely given risks to healthy EPS growth and PEs becoming too dependent on low yields.” The note continues, “we think the bull continues, but patience will be rewarded.”

Cautious optimism indeed.