The big problem for S&P 500 third quarter earnings hasn’t exactly crept in with investors. The stock market has been struggling since September and the reason can be summed up in an index that is currently trading at a price-earnings ratio above its long-term average due to many external factors such as rising commodity prices, wage inflation etc. inflation, chaos in the supply chain and interest rate policy become a headwind for stocks.
It was FedEx earnings released long before the big corporate earnings season began, with the mailer missing estimates significantly, and that was after analysts lowered estimates in the run-up to earnings reporting. The S&P 500 is not a good way to think about it, especially since it is now being dominated by technology, how companies are making profits and how different it can be this time around compared to all other quarters since the Covid low.
A crucial quarter for the S&P 500
Leading up to Q2 gains, growth estimates for the S&P 500 rose, but this time it wasn’t as growth estimates continued to decline in the weeks leading up to the big gains that started Wednesday with JP Morgan. Before the recent negative earnings revisions, there was nothing but increasing estimates over the past 12 months. It’s one of the reasons investors don’t have to struggle to understand why stocks have been performing since September. Stocks floated after the latest inflation data and the first big gains of the week came in on Wednesday after three straight days of losses.
“It was a lot easier to be bullish on US stocks when analysts raised estimates practically every week as they did until September,” stated DataTrek Research in a recent report.
And that hasn’t changed this month. Sam Stovall, CFRA Research’s chief investment strategist, says EPS estimates at this early point in the reporting cycle have typically started to beat estimates at the end of the quarter versus negative revisions by 1.7 percentage points by October 11 September 30th. He cited higher-than-expected oil prices, which Delta Air Lines commented on Wednesday, inflation, interest rates and a steady cut in GDP projections for the third quarter. Global growth will also continue to be downgraded.
According to Stovall, this could only be the second of the last 49 quarters where actual results have been below quarter-end estimates.
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Typically, at this early point in the reporting cycle, EPS estimates begin to beat estimates at the end of the quarter, but not this time.
“You invest in stocks because you want part of the action, and the action is in profits and dividends, and when the action wears off in terms of earnings growth, that’s not good,” Stovall said. “We saw 47 of the last 48 quarters (back to the second quarter of 2009); 47 of 48 actual revenues exceeded the estimates at the end of the quarter. And that by an average of 15%, ”he said.
Bank of America Global Research adopted a similar tone in a notice to clients this week, reminding them that lost profits are extremely rare but added that “the main focus will be on the forecast,” which has begun to weaken and lead to earnings per share in 2022 will be revised downwards. “We believe it will be a pivotal quarter with all eyes on margins and the supply chain,” wrote the bank’s research team.
Since the first quarter of 2020, the only failure in the last 48 quarters, earnings growth for the S&P 500 (Q2 2021) has reached up to 88%. That’s now down to 25% for the third quarter as earnings are hit hard. And Stovall said that if the bull market continues, investors should expect at least a more modest rise in the expected rise. “Q2 could be the best quarter in terms of percentage change in earnings growth,” he said. “It will continue to be positive, only a smaller percentage of it will be positive.”
Traders operate on the floor of the New York Stock Exchange (NYSE) on October 12, 2021.
Brendan McDermid | Reuters
Another positive way to read earnings from the street: DataTrek Research still believes analysts are too low on third and fourth quarter earnings.
Some of the slower earnings growth is to be expected. The consumer discretionary sector is projected to see a nearly 15% decline, but that’s because it fell so sharply in 2020 after posting triple-digit gains after hitting the Covid lows: 161% in Q1 2021 and 210% in second quarter of 2021.
The best earnings growth after Covid is over
Such earnings growth numbers “can’t be repeated,” Stovall said, and that’s one reason analysts don’t want to be overly optimistic. And even as negative revisions to the S&P 500 earnings outlook hit almost all sectors, especially those that had some of Covid’s biggest comebacks, including industrials, materials and consumer discretionary, Stovall insisted that the earnings revisions are an indication that the situation is “could be worse. Significant growth is still expected for some of the sectors with the strongest negative earnings revisions. It’s only increased by lesser amounts.
Another way to think about it: “Investors are going through earnings realignment rather than negative earnings revisions,” Stovall said. “What they are really doing is saying that we are in an unprecedented time, we have had tremendous GDP growth lately, relative GDP and earnings growth, and there is still an upward trend just because we are now have a real crisis behind us. ” for 2020, the forecasts will be less and less enthusiastic. “
That comes back to what DataTrek co-founder Nick Colas says that this could be the difference between this quarter and every other final quarter since the Covid outbreak – companies really need to provide guidance.
Investors are now in the “show me” phase of earnings recovery and that is a big change, especially as year-to-date S&P performance has been closely correlated with earnings expectations: US large-cap stocks enjoyed a year-long tailwind from the estimates that had plummeted amid Covid.
The price / earnings ratio of the S&P 500
The price-to-earnings ratio of the S&P 500 has dropped from a high of over 24x in January 2021 to around 21x, but that’s still a 28% premium over its average P / E since 2000.
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The S&P 500’s valuations are a bit high and that means that company forecasts for profitability that are above current expectations will be critical for the market to move higher.
The market is already trading at a P / E ratio that is above current earnings expectations for next year. That said, even if analysts raise earnings estimates after better-than-expected numbers, stocks may not burst because it is already expected.
What companies don’t say about 2022, their margin structure in the face of inflation, how much they have to pay for work, and other unknowns such as productivity effects from working from home. “A whole series of discussions that we have to get caught in the weeds of the cost structure for companies for the first quarter since Covid.
Actual earnings estimates for the S&P 500 do not support valuation above 18x the average over the past two decades, and to achieve a valuation of 21x requires an increase in earnings. “Companies have had incredible profit margins for the past 12 months,” said Colas. But for the S&P 500 to “just crawl into its current valuation”, investors need to be convinced that there is even more upside potential in the market in 2022, ”he said. “Reviews abound.”
For this reason, the message from Wall Street analysts and recent market volatility can be summed up to be central to this earnings season: the chapter on earnings recovery from last year’s lows is over.
“The growth from here will be slow and restless and exposed to external shocks, so how do you multiply that? That’s the hard part,” Colas said.
The optimistic side of the current market multiplier suggests that investors are still assuming that profitability is sustainably higher than before the pandemic, and that 5-10% more can be expected with higher revisions. The view from here is all the more important.
There are some basic things Colas believes in today: Nobody expects a recession. GDP and income will grow. And Big Tech will be a bigger part of the S&P 500 per year starting today.
But the right numbers for sustainable profit growth no longer play a role since the Covid low point. Now it’s them again, and the market isn’t really going to start again unless CEOs can convince investors that the outlook is good.
“For the past four quarters, it has not been true that guidance is the most important thing,” said Colas. “The surprises with the winnings were so big. … Now it stops.”