This quarter (Q3) marks a year since investors were told to be on watch for a so-called “profit reckoning” among US corporates.

The thesis was eminently plausible, and in many ways still is. Labor costs are higher and even if they stop rising, they won’t likely go into reverse absent a wave of layoffs. It’s not easy to take away someone’s raise, and if your employees are unionized well… suffice to say labor as an economic actor is on the comeback trail, even as the sheer amount of ground to make up after decades spent downtrodden means it’s far too early to declare any kind of renaissance. Wage bills are sticky, but pricing power may not be going forward given depleted pandemic savings buffers and so on. The read-through is margin pressure and negative operating leverage as inflation recedes, nominal growth slows and revenue growth flatlines.

Again, it made sense. And still does. So much sense, in fact, that it actually materialized. The US did experience a mild earnings recession, but it was so shallow as to scarcely register and all “famous last words” caveats aside, it appears to be over for all intents and purposes.

Q2 results are on the books, and S&P 500 earnings contracted just 4% YoY, less than half the decline consensus expected headed in.

Excluding energy, earnings actually grew 3% last quarter, the first increase since Q1 of 2022 for ex-energy EPS.

As discussed at length last month, there’s a lot of (legal) gamesmanship to account for. It’s in everyone’s interests for corporates to top estimates, and because the estimates emanate from bottom-up analysts who take their cues from management, there’s a sense in which bad misses mean somebody screwed up. Egregious misses aren’t really supposed to happen even when companies have egregious quarters. Reporting season is a choreographed exercise.

In a recent note, Deutsche Bank’s Binky Chadha and Parag Thatte reiterated that “underlying earnings,” which exclude both energy and loan loss provisions at banks, are now at a record high after rising 5.5% in Q2 on a QoQ, seasonally adjusted basis (see the figure on the right, below).

When taken with the prior quarter’s 4.5% increase, that measure of US corporate profits has now recovered the entirety of the 6.4% decline seen from Q1 to Q4 of last year — and then some.

The bottom would have to completely fall out this quarter (or in Q4 at the absolute latest) to make last year’s profit reckoning warnings correct. This gets back to the “shelf life” discussion. There has to be an expiration date on these kinds of warnings — a point beyond which calls are deemed wrong.

I trust (I hope) that if there’s no meaningful equity drawdown in the back half of the year, no US recession and no deeper profit contraction, that strategists and analysts will concede this time was in fact different. There’d be no shame in that. We’ve had a pandemic and a ground war in Europe’s breadbasket, after all. Top-down forecasting is hard enough (where that means all but impossible) under the best of circumstances. These aren’t the best of circumstances.

With Q2 reporting season complete, sales rose by 1% and margins compressed by 92bps. Those figures were likewise better than feared. Consensus expected flat sales and 140bps worth of margin contraction. On Goldman’s data, 54% of S&P stocks beat consensus EPS estimates by at least one standard deviation. As the bank’s David Kostin noted, that compares favorably to the 48% historical average.

Goldman is sticking with its S&P EPS forecasts of $224 for this year and $237 next. Kostin’s 2023 projection is higher than both bottom-up consensus and the consensus of his top-down peers. However, he’s still relatively cautious on 2024. Although Goldman likes what it’s seeing in terms of “cost discipline, falling input costs and moderating wage growth,” the outlook may be more challenging next year.

Consensus sees ~80bps of margin expansion in 2024. That’d put margins back near 2021 highs. “Although inflation and wage growth are moderating, both remain elevated, and we see substantial near-term margin expansion as unlikely,” Kostin went on.

Goldman’s 2024 EPS forecast is well below consensus due to Kostin’s expectations for what may as well be flat margins.

Note that Kostin’s below-consensus earnings outlook for next year still only implies a 6% revision from the original consensus. As the figure on the right above shows, consensus is usually revised down by 8%, so in that respect, Goldman’s forecast is actually optimistic.

In any case, the overarching point coming out of earnings season is that various “profit reckoning” calls and other dire warnings about a deep earnings recession simply haven’t panned out. And it doesn’t appear as though they’re going to be vindicated in Q3 either.