Pessimism on U.S. large-cap earnings is not priced in
As another year of ‘tape bomb’-driven stock market moves beds down into its final stretch, it’s easy to temporarily forget an arguably more important influence for equity prices: company earnings.
Well, even after risk aversion appeared to make a return in recent sessions, the S&P 500 was still less than 2% below its 2019 high at last check. Strong earnings were not the force that propelled the market to these levels - though appearances can be deceptive. Almost all of the benchmark index’s constituents have reported Q2 earnings by now, and around 74% beat analysts estimates. Lowered estimates, that is. Those estimates were down 11% compared to September last year till July this year.
Nor is there much of an expectation that large-cap corporate profits will rebound in coming quarters. The graphic below shows pessimism building after S&P 500 profits peaked in the third quarter of last year. It’s been downhill ever since, and according to analyst forecasts, the worst is yet to come.
S&P 500 revenue, net income, earnings estimates/actuals – Q2 2016 – Q1 2021
Source: Refinitiv/City Index
Investors weren’t always this pessimistic about recent and current quarters. Breaking out estimates of this year’s performance by S&P 500 companies, it’s fairly clear that a forecast ramp coincided with the advent of Washington’s huge tax cuts late in 2017. The sugar high didn’t last though. Worries about the trade conflict may even be impacting assessments of how major U.S. firms may fare as far out as 2021.
Aggregate S&P 500 profit estimates for 2019, 2020, 2021 – December 2017 – September 2019
Source: Bloomberg/City Index
The main saving grace for forthcoming earnings? A long-standing pattern for U.S. earnings to mostly beat estimates overall. Over the past 10 years about 70% of S&P 500 members have topped quarterly consensus estimates. In 2019, an aggregate 4% decline in first-quarter EPS was expected. Actual results showed 1% growth.
That said, whilst better-than-expected earnings are obviously preferable to the opposite, the relationship between earnings beats and stock market gains is far from direct historically. With the U.S.-China trade conflict unresolved and the S&P 500 trading 19% higher in 2019, the risk that the dispute fails to improve does not look priced in. Weak earnings forecasts are also out of whack with the market’s advance. U.S. stock market gains clearly reflect expected monetary policy support, though even that looks less certain after last week’s more hawkish than expected Fed statement. So, if U.S. equities need to fall back on earnings performance for stability, they are just likely to keep falling.
The S&P 500 continues to struggle below a broken optimistic rising trend line that can be traced back to the bottom of the winter 2018 correction. The notion of support is palpably invalidated, but the idea of resistance is compelling. Since the market fell back below the line in recent sessions, attempts to mount it have failed. That said, SPX’s busy—albeit volatile—consolidation mostly between early August and early this month has likely laid down some support. Consider the Monday 5th August low of 2822 following the high of Friday at the end of the previous week, 2945. Note that SPX didn’t emerge from that range till the big gap higher on 5th September. As the index appears magnetically drawn back to that range—which is in confluence with a nearby 38.2% retracement—buyers can take comfort that this region won’t give way without a fight.
S&P 500 – Daily 25/09/2019 19:44:02
Source: Bloomberg/City Index
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