Around 90% of S&P 500 companies have reported Q3 earnings now, so there is a big enough sample size to start looking at what can be learned from this earnings season. It is time to take stock (if you will forgive the pun); according to FactSet’s Earnings Insight, 70% of those that have reported have beaten EPS estimates, and 71% have done so in terms of revenues, with earnings growth of 2.2% over last year. Overall, that shows earnings growth slowing but still positive, and things that aren’t as bad as they could have been. More importantly in many ways, in the light of Q3 results, analysts are forecasting a bounce back in 2023.
One of the most important things to remember when looking at the stock market as a whole is that it doesn’t always reflect current conditions or available data. In fact, it rarely does. The market will react immediately to certain things in real time, good or bad, but those are almost always short-term moves. Longer-term moves are not about what is or what was, but about what will be. Or, at least, what analysts, traders, and investors think will be.
When Covid-19 forced an almost complete shutdown of the world’s economy, for example, stocks dropped dramatically in response to what was occurring, but the bounce back that took the market up beyond its pre-crash levels began while major restrictions were still in place. In the third quarter of 2020, companies were reporting big losses, but the market was soaring as everyone looked ahead to the recovery, not back at the finished quarter or at conditions at that moment in time. Analysts’ forecasts had already begun to look towards the end of the restrictions and the stock market was reflecting the expected bounce in early 2021.
Of course, as I have pointed out many times before, analysts’ estimates are wrong more often than they are right. On average over the last five years, 77% of companies beat expectations for earnings each quarter. So, we get the crazy situation we have this quarter, where 70% of S&P companies beating estimates on the bottom line is seen as a “bad” earnings season. As I said, though, that is not as “bad” as it could have been, and it has been the expectations for a bad Q3 and Q4 that have really driven stocks lower this year. The Earning Insight report last week contained a chart that showed just how much those expectations have dropped since July:
It is no wonder that the market has fallen.
The good news is that because on average, three quarters of S&P 500 companies beat estimates every quarter, there is a good chance that Q4 will still bring a positive earnings growth rate, albeit a very low one. Whether that materializes or not, there is also already a sign stocks are set up for a strong bounce next year. Estimates for 2023 are for positive growth throughout, with 7.2% now expected in Q3 of that year, and 9.6% in Q4. Bear in mind that the tendency is always to underestimate earnings, and that pricing is more about looking forward than backwards, and a strong case can be made that early 2023 will see a strong bounce in stocks.
As the end of this earnings season nears, it has been one of mixed messages. On the bad side in terms of earnings, fewer companies beat expectations than average, and the beats were by less than average. But on the good, growth was still positive, and revenues held up well, with more companies beating on the top line than is normal. All of that, combined with estimates for strong growth in the second half of next year, reinforces the view that there is underlying strength in corporate America such that even if the Fed does overstep the market in its fight against inflation and damages the economy, the bounce back will be quick and strong.
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