Q2 Earnings Season Forecast: Misses May Offer Buying Opportunities

By Hal M. Bundrick

NEW YORK ( MainStreet)--With the 4th of July holiday over, the earnings reports begin. And while expectations for second quarter earnings season are modest, with disappointing news can come "tremendous buying opportunities of quality names", according to Heather Brilliant, Morningstar global director of equity and credit research.

Thinner profit margins could be the catalyst for disappointing earnings news, especially among stocks with overseas exposure.

"I think that it's a reasonable expectation that record-high profitability cannot continue indefinitely," says Brilliant. "We're a little bit less concerned with businesses that are exposed to the United States and a little bit more concerned with businesses that still have a lot of exposure to Europe, and especially to China. We've been talking about China seeing industrial production come down, and we started to really see that play out. We think companies that are more exposed to that will certainly be affected."

The analyst also expects the market to continue to be rocked by wild swings.

"I wouldn't be surprised to see a lot of volatility during this earnings season," she says. "I do think that people have very high expectations priced into quite a lot of stocks. Generally speaking, wide-moat or really high-quality businesses have been particularly run up during the first six months of this year. So I do think that if these stocks do not meet Wall Street expectations, the Street could be very quick to punish them. But we think that could really lead to some tremendous opportunities because they are great businesses fundamentally. So if you see somebody like a Microsoft or Intel miss their quarter, then we think that could be a really good opportunity to get into wide-moat names at a discount."

Brilliant looks for weak second-quarter earnings reports from companies in the basic materials sector, even though valuations look attractive.

"We expect to see some miners make announcements about having to cut back on expenses, overhead, or even cutting projects," Brilliant says. "And that really goes back to the idea that a lot of the commodity prices have come down enough so that miners are really going to have to be more scrutinizing of all of the expenses they incur."

However, healthcare may provide a positive push during earnings season according to the researcher, due to companies carrying high cash levels on their books and with growing merger and acquisition activity in the sector.

Morningstar analysts are also looking for continued recovery in the auto sector and housing.

"Even as interest rates rise, we still think that there is enough demand and enough recovery in the housing market that we will see stocks related to housing do well and earnings coming in better in those areas, too," says Brilliant. "But on the other hand, businesses that are really exposed to refinancing can start to take a hit. As we start to see rates rise, refinancing usually stops very abruptly, and we are starting to see the signs of that. So we expect the second-quarter refinancing businesses will not be so well off."

--Written by Hal M. Bundrick

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