We’re more than halfway through the second quarter earnings season, and so far the figure reported have been relativity upbeat. With substantially all of the companies in the S&P 500 now having reported earnings according to FactSet, 69% have reported earnings above the mean estimate, and 54% have reported sales above the mean estimate. The blended earnings decline is 3.5%. 

Analyst Expect S&P 500 Earnings to Sink for Q3

Heading into the earnings season, many analysts were predicting a dismal quarter but many companies have announced results that met or beat consensus expectations. Whether this was a result of lower expectations or actual improved business performance is a question that remains up for debate.

Still, while the numbers are up for debate but on the conference calls over the past 30 days, four clear themes have emerged. Goldman Sachs has compiled the themes in its quarterly S&P 500 Beige Book.

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Consumers are strong, but sentiment is mixed

The first key theme that has been clear on the conference calls is the state of the consumer.

S&P 500 Earnings – 2Q16 EPS & Growth Rate

Managements have expressed concern that consumers are set to postpone spending due to rising political and economic uncertainty, making it harder for consumer-focused companies to hit revenue targets. However, financial firms spoke favourably of consumer credit profiles on second quarter conference calls, to some extent easing concerns about the state of the US consumer.

There are pockets of margin expansion

A profit recession has been one of the most concerning developments for the stock market this year.

Contracting margins at the index level have sparked fears of a profit recession, which usually precedes a recession or market crash. Goldman’s bottom-up conference call analysis shows a different trend. While at the index level margins appear to be contracting, some companies expanded margins by driving efficiency. The bank is forecasting that Energy sector margins will recover and ex-Energy margins will be flat through the end of the year.

Coca-Cola Co. (KO): Similar to gross margin, currency and structural headwinds impacted our operating margin. Excluding the effect of these items, our underlying operating margin increased about 180 basis points in the quarter…

Honeywell Intl (HON): On an operational basis, this was 110 basis points of improvement as we continue our focus on commercial excellence, execution on previously-funded restructuring actions and maintaining disciplined cost controls… We expect the overall margin expansion will continue to improve in the second half.

3M Co. (MMM): In the second quarter, we delivered healthy margins of 24.4%, up 50 basis points year over year…The combination of lower raw materials and higher selling prices contributed 130 basis points to our margin improvement, while lower pension and OPEB expense increased margins by another 110 basis points. Productivity gains related to last year’s fourth quarter restructuring expanded margins by an additional 40 basis points.

McDonald’s Corp. (MCD): In the U.S., company-operated margins increased by 30 basis points for the quarter, as positive comparable sales and favorable commodity costs more than offset the investment we made last July to raise crew wages and enhance benefits for our restaurant employees.”

The strong dollar was a headwind but firms have mixed outlooks for the second half

Firms faced a 5.7% year-on-year headwind from FX based on the trade-weighted dollar in Q2. Firms generally expect this trend to moderate throughout the rest of the year.

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Goldman has pencilled in a trade-weighted dollar headwind of 2.7% year-on-year for the third quarter. In fact, the dollar has weakened considerably against G10 currencies in 2016, suggesting that FX could become a tailwind to S&P 500 earnings in 2H.

Brexit

The fourth and final key theme that dominated Q2 conference calls was Brexit.

Firms are uncertain about the impact of Brexit pending terms of separation from the EU. Most managements believe that impact of the vote will be felt via lower interest rates, heightened currency pressures, and elevated uncertainty among consumers. Most firms have adopted a wait and see approach to Brexit fall out as it is not entirely possible to tell how much of an impact it could have on business.