How has the volatile environment of the last few years played out in corporate earnings?

After a year of exceptional earnings growth, the outlook for corporate profits has dimmed considerably this year, with current estimates virtually flat on a year-over-year basis for Q3. As a key driver of equity returns, understanding what’s taking place under the surface can provide some insight into underlying developments in the equity market.

As illustrated above, the primary sources of earnings growth have varied over the past few years. Coming out of 2020, the rising tide of explosive growth lifted earnings across all sectors, led by financials and growth-heavy sectors like technology, communication services, and consumer discretionary. That dynamic has shifted in 2022, as the comparatively small energy sector has been responsible for most of the modest increase, while earnings for most sectors have stagnated or declined. Without strong earnings growth in the energy sector, year-over-year S&P 500 earnings growth would’ve been negative in each of the first three quarters this year. Much of the volatility in equities this year was arguably a byproduct of the sharp spike in interest rates. Still, muted earnings results and dimmer profit expectations for the coming quarters have also contributed to that volatility, with companies that have posted earnings misses selling off sharply on the back of those disappointing announcements.

Will energy and “old economy” value-oriented sectors continue to lead? Will growth, technology, and other “new economy” stocks that have been under pressure stabilize and resume their growth trajectory in the near term? That remains to be seen. However, recent dynamics serve as a reminder that market leadership can change quickly, and remaining broadly diversified across a variety sectors, regions, and asset classes is an important part of constructing portfolios to reduce risk and maintain exposure to a broad opportunity set.