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(Bloomberg) — With Corporate America’s earnings season nearing an end, the takeaway is clear: Challenges remain, but for a broad swath of companies the worst of the profit pain is likely over as margin-shredding inflation pressures ease.

The bad news: S&P 500 Index companies are on track to notch a third straight quarter of profit declines, with per-share earnings down 7% after more than 80% of the guage’s members have reported. The good: the earnings outlook is getting better. Profit growth, excluding the energy sector, is forecast to return in the current quarter, Bloomberg Intelligence data show. 

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Optimism is returning to corporate boardrooms as data continue to show a resilient economy that can support further growth. The Federal Reserve is no longer forecasting that its aggressive tightening will tip the economy into recession. And prognosticators at Wall Street’s biggest firms, from JPMorgan Chase & Co. to Bank of America Corp., have dialed back their dire warnings of a downturn. Profit forecasts from the likes of Royal Caribbean Cruises Ltd. to Coca-Cola Co. suggest the American consumer is still willing spend.

“We may indeed avoid a recession in the coming quarters and the brunt of the pain in corporate profits is likely behind us, as long as inflation continues to ease and the Fed doesn’t surprise with tighter policy,” said Jimmy Lee, chief executive of The Wealth Consulting Group. “Companies are navigating a high interest-rate environment and strong wage growth better than feared, which counters concerns about a slowing economy.” 

A return to profit growth would give US equities a needed tailwind after a relatively bumpy second quarter. The 7% profit contraction would be the most since the pandemic bear market. And even though companies exceeded expectations at around the usual clip, investors haven’t been impressed. The benchmark equities gauge, which is up 17% in 2023, has climbed just 0.7% since earnings season kicked off July 14. 

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Here’s some of the key things we learned from second-quarter results:

1. Profit Beats Get Tepid Welcome

All told, companies in the S&P 500 that have exceeded projections on both earnings per share and sales have outperformed the S&P 500 by an average of 1% within a day of reporting, below the norm of the past six years, according to data compiled by Bloomberg Intelligence. Those that fell short underperformed the broader market by 1.7%, the least negative since the prior quarter. Arista Networks Inc. and Align Technology, Inc. had the most upside price returns, while DXC Technology Co and Generac Holdings Inc. were punished most.

2. AI Chatter Jumps, Inflation Fades

Mentions of inflation, supply chains and labor are rapidly declining as key buzzwords on corporate earnings calls as price pressures moderate, while commentary on recession and layoffs appear to have peaked, according to Bloomberg transcript analysis by Lori Calvasina, head of US equity strategy at RBC Capital Markets. Now, major themes that have emerged are artificial intelligence and inventory destocking, with both hitting fresh highs, while pricing optimism is beginning to fade.

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3. Likely End of Margin Pain 

Wall Street is taking a brighter view on operating margins, a key gauge of profitability that has a strong track record of signaling where stocks are headed. The consensus expects that operating margins troughed in the fourth quarter of 2022 after companies got squeezed with inventory overhangs, supply-chain snarls and escalating costs in the pandemic. But after cost-cutting efforts, strong margin improvement is forecast in the technology and communication-services sectors in the second half of 2023, while staples and health care are anticipated to struggle. 

4. Corporate America Reinvests More

US companies are pulling back on share buybacks and using that cash to spend on their businesses rather than handing the money back to shareholders. The median company pushed up capital expenditures by 15% last quarter, with three-quarters announcing programs that topped analyst estimates in July, data from Bank of America Corp. show. Companies ramp up spending on factories, equipment and other capital goods as they grow more confident in their financial outlook and the economy.

5. Profit Recession Almost Over 

Analysts are boosting profit forecasts for the coming year faster than they are marking them down. That’s pushed an indicator known as earnings-revision momentum for the S&P 500 — which measures the net direction of such moves — up by the most since May, according to BI. At the sector level, two key groups known for their ties to the health of the economy — industrials and discretionary — are leading positive revisions higher, while energy, materials and staples remain negative.

—With assistance from Lu Wang.

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