The serious problem for the S&P 500 profit in the third quarter did not particularly interest 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-to-earnings ratio above its long-term average, like many external factors including rising commodity prices, wage inflation, general inflation , supply chain chaos and interest rate policies become barriers to stocks.
This was in FedEx reports, which were released long before the start of corporate earnings season, when a shipper missed estimates badly, and it was after analysts had already downgraded estimates ahead of the income statement. Doing too much of any profit indicator is not the best way to think about the S&P 500, especially since it is now technology-dominated, but the fact that analysts have not underestimated FedEx earnings enough is remarkable to set the tone. how companies are making profits, and how different it might be this time around compared to all the other quarters since Covid’s bottom.
Crucial Quarter for the S&P 500
Ahead of the second quarter earnings report, estimates of the S&P 500’s growth were rising. This did not happen this time, as growth estimates continued to decline in the weeks leading up to major earnings starting Wednesday with JP Morgan. Until the recent revision of negative earnings, there was nothing but increase in ratings over the past 12 months. This is one of the reasons investors don’t have to struggle to understand why stocks have dropped since September.
“It was much easier to remain optimistic about US stocks with analysts raising their valuations almost every week, as they did until September,” says a recent DataTrek Research report.
And nothing has changed this month. Sam Stovall, chief investment strategist at CFRA Research, says EPS estimates typically started outperforming end-of-quarter estimates at the start of the reporting cycle, but that doesn’t happen when major corporate earnings start and the S&P 500 continues its upward trend. negative revisions were down 1.7 percentage points prior to October 11 compared to September 30. He cited higher-than-expected oil prices, which Delta Air Lines commented on Wednesday, inflation, interest rates and a steady decline in Q3 GDP forecasts. Global growth also continues to decline.
Stovall said it could only be the second quarter of the last 49 in which actual results were below quarter-end estimates.
Typically, EPS estimates start outperforming quarter-end estimates at this early stage in the reporting cycle, but not this time.
“You invest in stocks because you want to participate in the stock, and action is profit and dividend, and if action is declining in terms of profit growth, that’s bad,” Stovall said. “We saw 47 of the last 48 quarters (compared to the second quarter of 2009); 47 of the 48 actual revenues were above estimates at the end of the quarter. And they did it by an average of 15%, ”he said.
Bank of America Global Research addressed similarly toned clients in a note this week, reminding them that profit losses are extremely rare, but added that “the focus will be on the forecast,” which has begun to soften and will lead to 2022 per share per share. … revised below. “We believe this will be a watershed quarter in which all attention will be on margins and supply chain,” the bank’s research team wrote.
Since the first quarter of 2020, which was the only miss in the last 48 quarters, S&P 500 earnings growth has reached 88% (Q2 2021). This figure is now down to 25% in the third quarter, as it significantly reduced profits. And Stovall said that this means that if the bull market continues, investors should at least expect the expected rally angle to be more moderate. “The second quarter could be the best quarter in terms of percentage change in profit growth,” he said. “It will remain positive, only positive for a lower percentage.”
Traders work at the site of the New York Stock Exchange (NYSE), October 12, 2021.
Brendan McDermid | Reuters
Another positive way to look at the bottom line is that DataTrek Research still believes analysts are underreporting Q3 and Q4 earnings.
Some slowdown in profit growth can be expected. The discretionary consumer sector is expected to fall nearly 15%, but that’s because it fell hard in 2020 after posting triple-digit growth after the Covid low: 161% in the first quarter of 2021 and 210% in the second quarter of 2021.
These revenue growth figures “cannot be repeated,” Stovall said, and this is one reason analysts do not want to be overly optimistic. And even though negative revisions to the S&P 500 earnings forecast have affected nearly all sectors, especially those that have seen some of the biggest returns from Covid, including industry, materials and consumer rights, Stovall stressed that the earnings revision is a sign that the situation “could” be worse. Some of the sectors with the largest negative earnings revised are expected to still show significant gains. It just grew by a smaller amount.
Another way to think about it: “Investors are adjusting the profit estimate, not negatively adjusting it,” Stovall said. “What they are actually saying is that we are living in unprecedented times, recently we have had tremendous GDP growth, comparative GDP and income growth, and there is still an upward trajectory, simply because we are now in a period of real recession. for 2020, preliminary estimates will be less and less enthusiastic. “
That brings us back to what DataTrek co-founder Nick Colas said could be the difference between this quarter and every other quarter since the Covid outbreak – companies really need to follow the guidelines.
Investors are now in a show-me recovery phase in their earnings, which is a big change, especially given the year-to-date S&P performance has been closely correlated with earnings expectations: US large-cap stocks have taken a tailwind throughout the year. … estimated to have dropped too much amid Covid.
The S&P 500’s price-to-earnings ratio has declined from a peak in January 2021 of over 24x to about 21x, but that’s still a 28% premium to the average P / E since 2000.
S&P 500 estimates differ slightly, which means that the company’s earnings forecasts that exceed current expectations will be key to market growth.
The market is already trading at a P / E ratio that exceeds current expectations for profit next year. This means that even if analysts do end up raising earnings estimates after better-than-expected results, the stock may not rally because it is already expected.
What is not in the S&P 500 is what companies say about 2022, their margin structure, taking into account the push and pull of inflation, how much they have to pay for labor, and other unknown factors such as the impact on productivity due to work. at home. “There is a whole series of conversations that in the first quarter after Covid, we need to understand the cost structure of companies. This is no longer “wow, they are so far ahead, this is great,” said Kolas.
Actual earnings estimates for the S&P 500 do not support an estimate above 18x the average over the past two decades, and an increase in profit would be required to reach a 21x estimate. “The companies have had incredible profits over the past 12 months,” said Kolas. But now, for the S&P 500 to just crawl into its current valuation, investors will need to make sure there is more room for growth in 2022. market, “he said.” The estimates are high. “
This is why the message that Wall Street analysts and recent market volatility are sending can be summed up in a way that is central to this reporting season: the chapter on earnings recovery from last year’s lows is now complete.
“Hence, growth will be slow, intermittent and prone to external shocks, so how do you add a few factors to this? This is the hardest part, ”said Kolas.
The upbeat side of the current market multiple suggests that investors still believe that yields are consistently better than they were before the pandemic, and there is another 5% -10% that should be revisited. And that makes the perspective from here all the more important.
Here are some of the main things that Kolas confidently states today: Nobody expects a recession. GDP and income will rise. And from today, big tech will make up the bulk of the S&P 500 in a year from now.
But getting the right numbers for sustained revenue growth hasn’t been an important factor since the founding of Covid. They are back now, and the market will not start again unless CEOs convince investors of a good outlook.
“For the last four quarters, it has not been true that leadership is the most important thing,” said Kolas. “The surprises were so big … Now it stops.”