Stock bulls bet everything on earnings forecast with troubled record

S&P 500 topped pre-pandemic levels while earnings have yet to

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Photographer: Sukanya Sitthikongsak / Moment / Getty Images

You are never sure what the income seasons will bring. Hence their volatility. But one thing is certain about the about to be released first quarter results. They could not be less important for current market valuations.

And while this is a Wall Street cliché that ‘advice is what matters’, that view is being taken to absurd degrees right now, as the S&P 500 rates earnings that hardly can materialize. In two years. It is a level of faith in the future that history gives little basis to justify.

Here is the calculation. Based on analysts’ existing earnings forecasts for all of 2021, the S&P 500 is trading at nearly 24 times the estimate, among its highest valuations on record. To bring the multiple down to its long-term average of 16 times annual earnings, companies in the gauge will need to earn about 15% more than what equity researchers currently expect – in 2023.

Is it possible? Yes. Using a compound projected growth rate from 2019, this falls within the roughly 6% increase in revenue that S&P 500 companies have historically generated over time. But is there any good reason to suspect that anyone has a convincing opinion of what will happen in any given two-year period? It’s more cloudy. Given how much this point of view rests on this point of view, investors would be wise to think about what the market currently demands.

“What we’re talking about in mathematical terms is really a psychological phenomenon,” said Lawrence Creatura, fund manager at PRSPCTV Capital LLC. “It is mathematically observable that there are more downsides in the market than there were in March 2020, although, ironically, there It’s heard exactly the opposite.

Indeed, investors are pouring a record amount of new money into equities this year in hopes that vaccines and political support will bring the economy back to normal. Their willingness to pay for profits drove the S&P 500’s P / E ratio nearly 20% above its peak in the last bull market. Not that ratings are a good timing tool, but with so much optimism built in, the risk of those estimates not coming true is more dramatic.

Read more: An alternative to “no alternative”: how bonds crept into stocks

In theory, if earnings fail to catch up and the market’s multiple return “returns to normal” – the long-term average of 16, the S&P 500 risks losing a third of its value.

“Profits are absolutely critical and that’s really what you’re going to need to focus on right now,” said Jeff Mills, Chief Investment Officer of Bryn Mawr Trust. “Unless you continue to see the fundamentals materialize, you could see a dramatic reassessment.”

The Covid-19 pandemic and the massive fiscal stimulus models on Wall Street are complicating matters. Never mind in 2023: even getting an idea of ​​this year’s results is proving difficult. Going through analysts who study individual companies, S&P 500 earnings will rise 26% to $ 174 per share this year. Ask top-down strategists who forecast by tracking macro indicators like manufacturing and a wide range exists: from $ 152 to $ 202 per share.

Even hitting the high end of the strategist range would leave stocks trading at over 20 times earnings.

The huge gap is in part the result of an environment where, one year after the start of the pandemic, no one can confidently predict the lasting power of home-keeping demand or the increase in consumer spending through stimulus measures. The magnitude of profits affected by supply chain disruptions and rising commodity prices are also big wild cards.

Banks, including JPMorgan Chase & Co. and Citigroup Inc., will begin reporting next week. S&P 500 company profits in the first quarter are expected to rise 24%, the fastest since 2018, according to analyst estimates compiled by Bloomberg Intelligence. Leading the pack are automakers, retailers and banks whose profits have likely doubled from a year ago.

Analysts’ track record in estimating earnings has, unsurprisingly, suffered during the pandemic – although the fact that they have been shown to be too conservative is water for stock bulls. They underestimated the profit power of U.S. companies by an unprecedented rate of 20% on average over the last three quarters of last year. In the five years leading up to 2020, they have only missed 3%.

Analysts far missed the mark when predicting the benefits of a pandemic

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