Monday, October 21, 2019

Another Upside Hook for S&P 500 Earnings?

The Q3 earnings reporting season has started. Industry analysts’ estimates for the S&P 500 operating earnings per share plunged 8.7% from $44.85 at the end of last year to $40.93 during the 10/10 week (Fig. 1). As a result, the y/y growth rate in the consensus estimate for Q3 plummeted from 5.1% at the end of last year to -4.1% (Fig. 2).

It’s not unusual to see such downward revisions since industry analysts tend to be too optimistic about the future and become more realistic as the actual results approach during earnings-reporting seasons. Oddly, they tend to overshoot on the pessimistic side in the weeks before earnings seasons. That, in turn, means that there is often an earnings “hook” to the upside as actual results beat expectations.

I have weekly “earnings squiggles” data going back to Q1-1994. Of the 98 quarters since then through Q2-2019, there have been 77 such hooks by my count. (See S&P 500 Earnings Squiggles Annual & Quarterly.)

In addition to tracking the consensus earnings “squiggles” for each quarter, I do the same for the annual consensus earnings squiggles on a monthly basis (Fig. 3 and Fig. 4). They rarely show hooks, but they do confirm that analysts have an optimistic bias that gradually diminishes as each year progresses until their estimates converge with the actual annual results for S&P 500 companies.

My monthly data for the annual squiggles start in 1980, spanning 25 months from February to February. Of the 39 years since then through 2018, I count 30 years with descending squiggles averaging -17.8%. The 9 ascending ones, averaging 7.0%, tended to occur following recessions. Even optimistically inclined analysts tend to turn pessimistic during recessions. That sets the squiggles up for upside surprises during recoveries (Fig. 5).

Now let’s focus on the weekly data for the annual squiggles (Fig. 6). For the 10/10 week, they show that industry analysts expect that earnings per share will be up 0.8% y/y to $163.27 this year, up 11.2% to $181.53 next year, and up 9.2% to $198.23 in 2021. That puts S&P 500 forward earnings--which is the time-weighted average of consensus estimates for the current year and the coming year--at a record high of $177.67 during the 10/10 week.

Forward earnings tends to be a very good 12-month leading indicator for actual earnings as long as there is no recession over the next 12 months. If you agree with me that the economy should continue to grow through the end of next year, then forward earnings remains bullish for stocks.

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