Earnings are down less than feared in Q2, but the beats haven’t stopped negative forward revisions. Falling inflation may prevent companies from exercising pricing power. Here are 38 stocks that will revise earnings estimates higher, according to Morgan Stanley. US stocks continue to steadily rise as earnings exceed low expectations once again.
Corporate profits are on pace to fall 9% through roughly a fifth of the Q2 earnings season, which is about 6 percentage points better than anticipated, according to Morgan Stanley. Strategists at the firm also pointed out that sales are tracking flat after beating by 2 percentage points so far.
Although earnings are set to contract for the third straight quarter, the sense on Wall Street entering this earnings season was that these quarterly results will be the low point. Market veteran Ed Yardeni projects that profit growth will swing positive in Q3 and Q4 by 3.5% and 11%, respectively.
However, Morgan Stanley’s US equity strategy chief, Mike Wilson, isn’t convinced that the low point for earnings is here yet.
“Many of the 1H tailwinds are likely to fade at a time when forward earnings estimates, and stocks, are expecting a rebound in growth,” Wilson wrote in a July 24 note. “So far, 2Q earnings do not broadly support the notion that such a rebound is coming.”
Morgan Stanley In fact, the firm found that earnings revisions decelerated in two thirds of industries in the weeks since early July. That’s cause for concern as a seasonally challenging time for revisions nears — earnings revisions breadth traditionally trends downwards in the months of July through November.
“Forward-looking earnings revisions breadth has rolled over once again, falling at the most significant rate of change since late last year,” Wilson wrote.
Morgan Stanley An unexpected threat for stocks: Weaker inflationIronically, lower inflation may be to blame if earnings slide in the second half of the year. While most market pundits expected last year’s multi-decade-high price growth to weigh on profits, it instead gave firms substantial pricing power — an advantage that Wilson noted is now fading.
“Disinflation is now eating into sales growth, which means investor focus is likely to shift toward top-line growers rather than just companies exhibiting cost efficiencies,” Wilson wrote. He later added that “stagnant pricing power is met with lagged and elevated costs.”
Morgan Stanley expects nominal earnings and sales growth to suffer as price growth slows faster than expected, even if long-awaited interest rate cuts come. The dreaded scenario for companies would be if revenue growth recedes while costs stay elevated, Wilson noted.
“If we are right about pricing fading amid falling inflation, then sales will likely disappoint further from here,” Wilson wrote. He also noted that lower demand is beginning to rear its head in certain sectors, especially those that are goods-oriented.
38 stocks to buy for strong earnings growthAs inflation falls, the pressure on companies to maintain the pricing power they’ve commanded while increasing earnings at the rate the market expects will only increase.
In this environment, firms with strong guidance for the second half of the year should stand out, which may result in gains for investors who identify those stocks early.
Morgan Stanley recently shared a list of 38 large US-based stocks that have a bullish overweight rating from the firm, and are in the top 20% of earnings estimate revisions. These strong upward revisions are, in part, enabled by robust revenue growth.
Below are the 38 names that Morgan Stanley is bullish on now that will enjoy resilient earnings growth, along with the ticker, market capitalization, sector, and industry for each.