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Profit bar lowered as second-quarter reporting begins

by xyonent
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Corporate Earnings Market Up E1719769276985.jpg

As we enter the second quarter earnings reporting period, Wall Street analysts continue to significantly lower their earnings thresholds. Despite analysts lowering their earnings thresholds, stock prices have soared over the past few months.

As previously discussed, many companies “beat” Wall Street expectations. Of course, analysts’ expectations are revised downwards significantly once the reporting period begins, so the rate of beats is always high. The chart below shows the change in the second quarter earnings period from when analysts first issued their expectations in March 2023. Analysts have significantly lowered their expectations over the past 30 days, lowering their forecasts by about $5 per share.

This is why we call this “Millennial Earnings Season”: as earnings season approaches, Wall Street continually lowers expectations and “everyone takes a trophy.” A simple way to see this is to look at the number of companies that beat expectations every quarter, regardless of the state of the economy or finances. Since 2000, about 70% of companies have regularly beaten expectations by 5%, but since 2017, that average has risen to about 75%. Again, “Beat Rate” If investors had maintained analysts’ original estimates, the stock price would have fallen significantly.

Analysts remain optimistic about earnings despite weaker economic growth, persistently high inflation, and declining liquidity. But despite lower second-quarter earnings expectations, analysts still see the bottom of the earnings decline in the first quarter of 2023. Again, this is despite Fed rate hikes and tighter bank lending standards slowing economic growth.

However, between March and June of this year, analysts lowered their 2025 forecasts by about $9 per share.

But even if the earnings bar drops going forward, earnings forecasts remain out of step with long-term growth trends.

As mentioned earlier, the economic growth from which companies earn revenues and profits also needs to be strong for profits to grow at the expected pace.

Since 1947, earnings per share have increased 7.72% and the economy has expanded 6.35% per year. This close relationship in growth rates makes sense, given that consumer spending plays a key role in calculating GDP. However, nominal stock prices averaged 9.35% (including dividends) Eventually, there will be a return to fundamental economic growth. This is because corporate profits are a function of consumer spending, business investment, imports, and exports. The same goes for corporate earnings, and stock prices have fluctuated wildly.

Corporate profits and real GDP.

This is essential for investors considering the upcoming impacts. “evaluation”.

Given current economic assessments from Wall Street to the Federal Reserve, we don’t expect strong growth rates, and the data also suggests that mean reversion is quite possible.

Reversion to the mean

After the sudden tightening of monetary policy and economic shutdowns caused by the pandemic, the economy is slowly returning to normal. Of course, normal may look very different compared to the economic activity we have witnessed over the past few years. There are many factors that support the idea that we will see slower economic growth and, as a result, lower earnings in the coming years.

  1. The economy is returning to a low-growth environment with the risk of recession.
  2. Inflation is falling, meaning companies have less pricing power.
  3. There is no artificial stimulus to support demand.
  4. The frontloading of consumption over the past three years will act as a drag on future demand.
  5. Interest rates remain significantly higher, impacting consumption.
  6. Consumer savings have plummeted and debt burdens have increased.
  7. What was previously a shortage is now an overstock.

In particular, the return of this activity “Vacancies” Created by Bring forward future consumption.

“We have previously noted the inherent problems with ongoing monetary intervention, particularly the fiscal policies implemented after the pandemic-induced economic shutdowns created a surge in demand and unprecedented corporate profits.”

As shown below, the surge in M2 money supply has ended, and without further stimulus, economic growth will return to a more sustainable, lower level.

The media often says “Stocks are not the economy” As mentioned above, economic activity generates revenues and profits for companies. Therefore, stock prices cannot grow faster than the economy in the long run. M2 expansion and contraction minus GDP growth (Indicators of excess liquidity and the annualized percentage change of the S&P 500 Index. This deviation now appears unsustainable. Even more remarkable is that the current annualized percentage change of the S&P 500 is approaching levels that preceded a growth rate reversal.

Thus, the annualized return of the S&P 500 will either fall as the market reprices itself in response to lower than expected earnings growth, or the liquidity measure will rise sharply.

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Valuation remains at risk

The problem with Wall Street consistently lowering its earnings standards by lowering future earnings forecasts is obvious. Investors are overpaying for their investments given that Wall Street is touting future earnings forecasts. Obviously, if you overpay for an investment today, your future earnings will be lower.

While peak revenues have declined, past and future valuations remain historically high. (Note that valuations during downturns can vary widely, as adjusted earnings do not reflect actual earnings.)

Most companies “operating” Profits obscure profitability by excluding all benefits. “Bad quality.” There is a big gap between operating profit and operating income. (or adjusted) With such a large gap between GAAP earnings and “quality” of its revenue.

The chart below uses GAAP earnings: Assuming current earnings are correct, the market would be trading at over 27 times earnings. (This valuation level remains close to the peak valuation levels of the previous bull market.)

The results are likely to be positive, as the market is already trading well above its historical valuation range.strong” That’s exactly what many now expect, especially if there is no further monetary easing from the Federal Reserve and the government.

S&P 500 Historical Valuation Range

Trojan Horse

As always, we’re looking for second quarter earnings and overall reports for the year ahead to be upbeat and justify the market’s overvaluation. But when earnings rise, so does the market.

Most importantly, there is a long and ignoble history of analysts being overly bullish on growth expectations that never materialized. This is especially true today, when much of the economic and earnings growth was not organic but was the result of a flood of stimulus that was pumped into the economy that is now fading.

Overpaying for an asset never ends well for an investor.

With the Federal Reserve trying to slow economic growth to tame inflation, it stands to reason that earnings will fall, and stocks will have to respond to the decline by lowering their current valuation multiples.

It’s always wise to be cautious when it comes to analyst forecasts. “Greeks Bearing Gifts”

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02/07/2024

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