Wall Street expects earnings to reach a four-year high. Too conservative, says Deutsche Bank.
Retail investors have been "skipping the dips, selling into rallies, and positioning more defensively," according to JPMorgan.
The bank noted such activity was in evidence even during Wednesday's rally, which that cohort sold into - a marked departure from its behavior last year. That's as institutional investors have also backed away from U.S. stocks this year, against a backdrop of a volatile Middle East conflict and worries over AI disruption.
But those bearish attitudes may be about to meet their match, with first-quarter earnings growth expected to come in at a four-year high, according to Deutsche Bank strategists led by Binky Chadha.
Deutsche expects S&P 500 first-quarter annual earnings growth of 19%, which would beat the already "high bar" of 16.2% forecast by Wall Street analysts. Goldman Sachs will kick off the reporting season on Monday.
"Equity investor positioning meanwhile is significantly underweight and in line with an imminent collapse in earnings growth. Positioning is notably low for sectors in the market crosshairs currently, like financials and tech, especially software," Chadha and his team told clients in a note on Wednesday.
Line graph illustrating S&P 500 consensus earnings growth expectations (%) from March 2007 to March 2026, showing peaks corresponding to recoveries from the 2008-09 global financial crisis, the COVID-19 pandemic and the 2018 tax cut.
The team said that 16% growth represents a level "rarely expected at the start of any earnings season," but it's justified, according to Chadha and company, by a favorable macro environment, rising cyclical growth drivers and a weak-dollar tailwind.
That would be the strongest quarterly growth in four years, up from 13.4% in the fourth quarter and an 8.5%-to-14% range over the past two years, according to the bank. In the last two decades, the consensus has been this strong only three times: during the recovery from deep slumps from the 2008-09 global financial crisis, amid the rebound from the COVID-19 pandemic and as a boost from the corporate-tax cuts of the first Trump presidential term was being registered.
Deutsche Bank said earnings growth would broaden out across sectors, with 10 of 11 in positive territory, led by megacap growth and tech. That category, which has seen growth above 24% in every quarter since the third quarter of 2023, should see earnings growth jump to 35.7% from 27.5% in the fourth quarter, led by semiconductor manufacturers.
The team also sees financials shining, from growth of around 11% in the lower half of the range of the prior quarter to nearly 20%. Industrials, driven by continued artificial-intelligence demand and some manufacturing pickup, are expected to bounce from 2.8% to 7.9%. Consumer cyclicals could see some modest improvement, from contraction of 7.5% to a drop of just 1.6%.
As for the tailwinds, the strategists said a 6.8% annual drop for the dollar in the first quarter was the biggest in around five years, and probably boosted S&P 500 earnings growth by a "sizable" 4.1 percentage points. Energy, materials, megacap growth stocks and tech and industrials would be the biggest beneficiaries.
Higher oil prices may only give energy earnings a modest boost in the quarter, given that they are only up by 2% annually on a quarterly average basis. "If oil prices stay elevated, they will be a significant boost to energy earnings in the coming quarter," the Deutsche Bank strategists said.
Their chart showed where investors are positioned ahead of the start of earnings season:
Line graph showing equity positioning and S&P 500 EPS growth from December 2010 to December 2026.
"Equity positioning has historically been well correlated with earnings growth and is in line with the latter turning negative imminently, a farcry from the strong growth we expect in Q1," said Chadha and team.
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