Low Expectations Mark Q2 Earnings Season... Five 'Real Variables' to Watch [Bin Nansae's Thorough Wall Street]

On the 15th (local time), the Q2 U.S. corporate earnings season officially kicks off with the results announcements from major banks and financial institutions such as JPMorgan Chase, Citigroup, and BlackRock. Since President Donald Trump’s announcement of reciprocal tariffs on April 2, the intensified trade war drama raises the question of whether—and to what extent—corporate margins have been affected; this is in fact the first quarter when this can be gauged.

To start with, expectations are low. Although Bloomberg Intelligence (2.5%), FactSet (4.8%), and Bank of America (4%) each offer slightly different forecasts, the consensus on Wall Street is that Q2 S&P 500 companies’ earnings per share (EPS) growth rate will be at its lowest since Q2 2023 in two years. Of course, it is also seen as positive that EPS growth is expected to continue for an eighth consecutive quarter.

Since the bar is set so low, Wall Street is also predicting a high likelihood of ‘earnings surprises’ where actual results exceed forecasts. Given the multiple tariff deferrals and the fact that companies stockpiled inventory before tariffs were imposed, there’s ample chance that tariff effects won’t show in Q2 either. In other words, actual company margins could far outpace the market’s muted expectations. The Charles Schwab Corporation anticipated, “Since the effective tariff rate didn’t reach double digits even through May, Q2 results likely won’t fully reflect the tariff impact.”

In fact, in U.S. earnings seasons, such earnings surprises are more the norm than the exception. According to FactSet, out of the last 42 quarters, only three lacked earnings surprises.

Once again, the Q2 results themselves are likely to exceed these rock-bottom expectations. This means market participants’ attention will shift increasingly from rearview earnings to future outlook. Key points of interest will be: △ Whether companies that withheld guidance in Q1 due to tariff uncertainty will issue it this time △ How they are coping with a new high-tariff environment △ What commentary they might provide regarding the anticipated effects of President Trump’s fiscal and tax package, the so-called 'One Big Beautiful Bill (OBBB)', etc.

For example, Mike Wilson, CIO at Morgan Stanley, has predicted an optimistic outlook, saying that the $3.4 trillion OBBB would positively impact the cash flow of various sector companies including technology, communication services, healthcare, and energy. If such forecasts are confirmed through actual management commentary, it could be a positive catalyst for the stock market.

Ned Davis Research pinpointed five key factors to watch this earnings season. First, whether the upward trend in corporate margins has been maintained.

With tariffs yet to show much effect, the profit margin trend for the S&P 500 also remains stable. As of end-June, the total gross profit margin for S&P 500 companies is estimated at 37.45%, up 0.03 percentage points from the previous quarter. This aligns with the anticipation that tariff-induced margin contraction hasn’t yet materialized.

Conversely, if gross profit margins fall in Q2 against expectations, it could signal that tariffs are beginning to impact corporate profits. This could snowball into a macroeconomic shock with companies subsequently reducing headcount after a lag.

Second, whether the high proportion of earnings surprises seen in Q1 will continue. In Q1, 78.4% of S&P 500 companies outperformed market expectations, reversing a three-quarter decline. Ned Davis Research notes that if the rate stays in the high 70% range for Q2, it would indicate that companies are highly adaptive to tariffs and macroeconomic conditions, acting as a positive catalyst for the market.

However, the story is slightly different for small-cap stocks. For the S&P 600 small-cap index, the earnings surprise ratio fell from 67.3% in Q4 last year to 65.7% in Q1. If it drops again this time, it could signal weakening fundamentals for small caps—a factor that could fuel concerns about the fragility of large-cap-led rallies in the market.

Third, whether H2 earnings guidance will be further downgraded. According to S&P, Q3 and Q4 quarterly EPS growth rates for S&P 500 firms are expected to approach 13%. Though this is down from 20% at the start of the year, **Ned Davis Research notes it still seems overly optimistic considering current macroeconomic conditions such as inflation and employment indicators. If companies lower their outlook for the second half through Q2 releases, market expectations will also need further adjustment.

Fourth, whether the 'Magnificent 7' (Meta, Amazon, Microsoft, Apple, Google, NVIDIA, Tesla) will continue to lead the market. Through Q1 this year, the EPS growth gap between the Magnificent 7 and the other 493 S&P 500 companies had started to narrow. The Magnificent 7’s EPS growth slowed from 57% to 31%, while the other 493 recovered modestly from 0% to 4%.

However, looking at EPS growth forecasts over the next year from Q2 onward, the market expects this gap to widen again. There’s concern that the future earnings estimates for the remaining 493 companies—more vulnerable to tariff pressures than the mega-cap techs—could weaken further.

Ultimately, with the recovery among the rest of the companies lackluster, the earnings dominance of the Magnificent 7 could become even more pronounced, driving the entire market. The situation where a small number of large-cap techs lead the rally, resulting in narrow market breadth, could intensify. Depending on Q2 guidance, this outlook may or may not become reality.

Fifth is whether there will be a structural slowdown in EPS growth rates among U.S. companies. In other words, the momentum for profit growth could enter a stagnation phase in the medium term. As of Q1 this year, the trailing four-quarter cumulative GAAP EPS growth rate for S&P 500 U.S. firms stood at 13.2%. It is forecast at 13.8% for Q1 next year—a similar level, but Ned Davis Research points out that the momentum has already entered a plateau. If guidance for H2 earnings is revised downward, concerns about slowing profit growth could act as a headwind for stock prices.

Even amid persistent uncertainty around tariffs and various geopolitical risks, the U.S. stock market has remained strong near record highs. Whether this Q2 earnings season will serve as a tailwind or headwind for the market remains to be seen.

New York = Bin Nansae, Correspondent binthere@hankyung.com