Stock Bulls bet everything on earnings guess with tough record

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You are never sure what earnings seasons are going to yield. Hence their volatility. But one thing is for sure about the results of the first quarter to be announced. This could not be less important for the current valuations of the market.

And while it’s a Wall Street cliché that ‘leadership is what matters’, the view is currently being taken to absurdity, when the S&P is pricing in 500 profits that are virtually unattainable in two years. It is a level of confidence in the future that gives history little basis to justify.

Here’s the math. Based on existing analysts’ forecasts for earnings in 2021, the S&P 500 is trading almost 24 times the estimate, one of the highest valuations ever. To reduce the multiple to its long-term average of 16 times annual profits, companies in the measure will have to earn about 15% more than the stock researchers currently expect them to earn – by 2023.

Is it possible? Yes. Using a compound projected growth rate starting in 2019, it is within the approximately 6% increase in revenue that S&P 500 businesses have historically generated over time. But is there strong reason to suspect that someone has a convincing view on what will happen during a specific two-year period? It’s cloudy. Given the amount that rests on this view, investors would be wise to consider what the market is currently demanding.

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

Indeed, investors are pouring a this year a record amount of new money in equities amid hopes that vaccines and policy support will bring the economy back to normal. Their willingness to pay the earnings caused the S / P 500’s P / E ratio to rise almost 20% above the peak during the last bull market. Not that valuations are a good timing, but with so much optimism, the risk of these estimates not coming true is more dramatic.

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Hypothetically, if earnings do not catch up and the market’s multiple return is ‘normal’ – the long-term average of 16, the S&P 500 is in danger of losing a third of its value.

“Earnings are absolutely critical, and that’s really what you need to focus on right now,” said Jeff Mills, chief investment officer at Bryn Mawr Trust. “Unless you keep seeing that fundamentals deliver, you can see a dramatic reassessment.”

Complicating matters is the Covid-19 pandemic and massive fiscal stimulus emerging on Wall Street. No matter in 2023: it’s hard to master even the year’s results. Go through analysts studying individual companies, S&P 500 earnings will rise 26% to $ 174 per share this year. Ask for top-down strategies that provide predictions through macro indicators such as manufacturing, and a a wide range exists: $ 152 to $ 202 per share.

If you reach even the highest point of the strategy range, it can trade more than 20 times the profit.

The huge gap is partly due to an environment where no one, one year into the pandemic, can confidently predict the lasting power of the demand for housing, or the boost of consumer spending on stimulus tests. The extent of the profit made by the supply chain interruptions and rising commodity costs are also big game cards.

Banks, including JPMorgan Chase & Co. and Citigroup Inc., starting next week. Profits from the S&P 500 companies are expected to rise by 24% in the first quarter, the fastest since 2018, according to analysis compiled by Bloomberg Intelligence. Forerunners are carmakers, retailers and banks whose earnings have probably doubled as a year ago.

Analysts’ record of profit estimates, surprisingly, suffered during the pandemic, although the fact that it turned out to be too conservative is a big question for livestock bulls. In the last three quarters of last year, they underestimated the US corporate earnings power by an unprecedented 20%. During the five years before 2020, they missed by only 3%.