Third quarter earnings season begins in earnest this week, and Wall Street analysts expect earnings growth won't be negative for the first time this year.
The second quarter's 6% earnings decline was the "trough," according to Bank of America's equity strategy team.
"It gets better from here," BofA strategists Ohsung Kwon and Savita Subramanian wrote in a research note on Wednesday.
Notably, the Street's consensus projections aren't for stellar earnings growth in the third quarter but rather flat earnings compared to the same period a year prior. In the fourth quarter, the picture improves further as Wall Street expects earnings to grow at a 9% clip.
Both Bank of America and Evercore think the third quarter earnings growth projection is too low.
Evercore ISI senior managing director Julian Emanuel sees more upside to earnings driven by the stronger-than-expected economic data that poured in throughout the third quarter. On Tuesday, the Atlanta Fed's GDPNow tool projected the economy grew 5.1% in the third quarter, up from an initial forecast of 3.5%.
Emanuel describes third quarter expectations as "muted," which he believes sets a low bar for earnings beats and therefore provides "opportunities from potential surprises given the still strong economic backdrop."
Bank of America's team notes that dating back to 1950, quarterly earnings growth has typically outpaced GDP growth by 1.5 percentage points. That hasn't happened in the past five quarters as the post-pandemic economy shifted to one favored by services over goods.
But zooming into recent economic data shows manufacturing activity had been catching up to services activity throughout the third quarter. BofA's team notes that has "historically been a tailwind" for earnings leading GDP.
Broadly, earnings are considered the main driver of stock prices, Emanuel said. And after weeks of "higher for longer" rhetoric from the Fed and rising bond yields spooking markets, earnings season could be a welcome sign for investors.
"3Q23 earnings season which starts on Friday the 13th will likely be a catalyst for Winners to start Winning again, leading the broad market to at least 4,450 by year end," Emanuel wrote in a research note on Sunday.
Will AI still be the stock driver?
Artificial intelligence mentions will still be the trend to watch in the third quarter, and the reason is twofold. For one, the prospect of technological innovations drove stocks higher during first quarter reporting season. With many of those Magnificent Seven stocks off their 2023 highs after the two-month market sell-off, investors may once again be buyers of the AI hype at their current valuations.
"Winners are posed to win again," Emanuel wrote.
He highlighted Apple (AAPL) and Microsoft (MSFT) as two of those stocks that could outperform.
In the second quarter, AI wasn't as big of a driver for tech stocks. Companies like Microsoft told investors AI would be a big part of their business but won't immediately contribute to earnings growth. The hint that investors need patience sent some stocks lower.
BofA expects more clarity on AI projects this quarter and believes the tech will be a meaningful contributor to earnings growth in the future. The team projects AI could boost S&P 500 operating margins by 250 basis points over the next five years.
"While citing it as a tailwind, companies were hesitant to put numbers around it in 2Q," BofA's equity team wrote. "But we may start to hear more clarity this quarter."
Josh Schafer is a reporter for Yahoo Finance.
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