A reset in earnings expectations could spark a Fed pivot and entice investors into buying stocks again, JPMorgan says

• A reset in 2022 earnings expectations could spark a Fed pivot by September, JPMorgan said.
• The bank said such a pivot would likely lure investors into buying stocks and taking on more risk.
• "Investors could begin to look through more challenging EPS newsflow as we move through summer," JPMorgan said.

A reset in 2022 earnings expectations could cause the Federal Reserve to pivot from its current policy of raising interest rates and hit pause, JPMorgan's Marko Kolanovic said in a note on Wednesday.

Such a move by the US central bank would likely lure investors into buying stocks and taking on more risk, helping buoy a market that entered bear territory in the first half of the year.

Early second-quarter earnings results have shown that the bar to meet has already been lowered by investors, with Netflix the latest company to show that a not as bad as feared quarter could lead to a gain in its stock price. The company reported a loss of about 1 million subscribers, instead of the estimated 2 million subscribers.

"The hurdle rate for Q2 earnings is low, though second half numbers could come under pressure," Kolanovic said. "Investors could begin to look through more challenging EPS newsflow as we move through summer."

That's because Wall Street estimates for 2022 earnings have been revised higher year-to-date, despite ongoing headwinds from higher interest rates, rising inflation, and geopolitical uncertainties.

"A reset of earnings expectations could be taken as a positive as investors stop seeing estimates/guidance as being behind the curve," Kolanovic explained, adding that stock prices tend to peak ahead of an earnings peak, and bottom ahead of an earnings trough.

A downdraft in 2022 analyst earnings estimates in the second half of the year could also serve as reason for the Fed to consider a pause in its interest rate hikes, according to the note. The Fed is expected to raise interest rates by 75 basis points at its meeting later this month.

Any downturn in corporate earnings would likely be mild as compared to the 20% to 50% historical earnings declines seen during recessions. That's because wage growth has not been keeping pace with inflation, which gives businesses some flexibility in their profit margins.

By contrast, profit margins fell considerably in the 1970s when inflation, wage growth, and interest rates were all in double digit territory.

"The current slowdown could see nominal GDP meaningfully positive, still supporting the corporate top line," Kolanovic said.

"While resilient data were seen as bad so far year-to-date, enabling the Fed to keep tightening, weaker dataflow the next few months could open the doors for the Fed pivot by September, and could tempt investors to step in the market, looking for the inflection point," Kolanovic concluded.