The 2nd quarter earnings cycle is just around the corner, and it could be exciting for the S&P 500 (NYSEARCA: SPY). The indications are as mixed as they could be, which means we are likely to see mixed results across sectors and industries and rotation within the market. This recipe for volatility could increase or lower the market depending on how the news comes out. Between then and now, there are opportunities for investors and traders if you know where to look.

The Q2 Cycle Will Be Better Than Expected 

It is easy to say the Q2 cycle will be better than expected because the statistics suggest that is the case. The question is how much better than expected, how the outlook will change, and which sectors will lead the market. Based on the Q1 results, Q2 should be about 400 basis points better than expected, which puts the end-of-cycle growth rate near -2.25% based on the recently released -6.4% consensus figure. 

The sectors that stand out are Consumer Discretionary (NYSEARCA: XLY), Energy (NYSEARCA: XLE), Communications (NYSEARCA: XLC), Industrial (NYSEARCA: XLI), and Information Technology (NYSEARCA: XLK). The Consumer Discretionary Sector is expected to post the largest growth in Q2 and for the year, but it also sees the largest downward revisions. That should continue this quarter and for the year. The growth drivers within the sector are Amazon (NASDAQ: AMZN) and Tesla (NASDAQ: TSLA), supported by the EV movement and growth in the cloud/AI, which has nothing to do with consumer discretionary spending. Those companies should do well, but true discretionary names will likely report similar results to Foot Locker’s (NYSE: FL) Q1. 

The Energy Sector is expected to post the most significant earnings decline, 46% for the quarter and 26% for the year, and is seeing large downward revisions. The takeaway is that this is on top of high-tripel-digit growth last year and will still deliver solid earnings, cash flow, and capital-return power. However, the sectors that will dominate the attention are Communication Services and Information Technology due to the rise of AI. Oracle’s (NYSE: ORCL) FQ4 report is reminiscent of NVIDIA’s (NASDAQ: NVDA) Q1 release, which means game-changing results driven by demand for AI infrastructure and services. The caveat is that many gains may be priced in when the EPS results come out. Oracle’s pop was met by profit-takers just like NVIDIA’s. 

“Both of our two strategic cloud businesses are getting bigger—and growing faster. That bodes well for another strong year in FY24." said Oracle CEO Safra Catz.

A Headwind For The Market 

Regardless of the results, there is a headwind for the market, and it will get stronger before it gets weaker. Interest rates are expected to rise by another 25 basis points at least. The May CPI data cooled as expected, but the core data remains hot and well above the Fed’s 2% target rate. That will keep the Fed in tight mode, if not tightening mode, and that impacts demand. The latest Retail Sales figures show growth but not enough to account for the rise of inflation. At 1.6% YOY, retail sales are down on a volume basis and offset by a 4% increase in headline pricing. With pricing on the rise, demand will continue to shrink and margins under pressure which is not a recipe for earnings growth. 

The S&P 500 is moving higher and could continue to rally into the summer. As it is, the index is on track to retest all-time highs, and it may do before or during the Q2 earnings reporting cycle. The risk is that the outlook for the 2nd half, which is already trending lower, will continue to trend lower, as has happened over the past 8 reporting cycles. In that scenario, the S&P 500 could hit a new all-time high, but it is unlikely to sustain it.