The Earnings Bar is High for Corporate America

The Earnings Bar is High for Corporate America

Stocks entered a cyclical bear market in 2022, and perhaps for good reason. Yes, interest rates were on the rise. Yes, valuations in 2021 were extended and needed to cool off. Yes, geopolitical turmoil and inflation weighed on the market’s collective mind. Yes, economists were practically unanimous in their calls for a broader U.S. economic recession in 2023.

Putting all of that aside, it’s also possible that the bear market in 2022 was a simple matter of stocks discounting a corporate earnings recession that started just as the S&P 500 bottomed out in Q4 of 2022. In the table provided by the J.P. Morgan Guide to the Markets below, you can see that in aggregate S&P 500 companies experienced three consecutive quarters of year-over-year declines in profits from the fall of 2022 to the summer of 2023:

Data as of 7/19/24

Fast forward to today, and you could also make the case that the market’s recent run-up has been discounting better days ahead. For the most recent quarter-end (Q2 2024), analysts have forecasted earnings growth of 10% for the S&P 500. Earnings are also expected to increase by 7% in Q3 and another 18% in Q4.

As always, there are many caveats to the earnings outlook. First and foremost, even if the projected path for earnings growth comes to pass over the next few quarters, it says nothing about what stock prices will be doing in real time (the goalposts for future expectations are constantly moving!). Second, today’s assumptions about future earnings are almost certain to be wrong (they’ll be either too aggressive or too conservative). There’s also the obligatory caveat that “exogenous shocks” could derail economic activity and business profitability, and then all bets for the stock market are off.

From my perspective, the bar has been set fairly high for corporate America, but that’s okay! It is quite possible that the analysts tracking S&P 500 companies have nailed their forecasts and we are due for a healthy rebound in corporate profits.

If analysts have set the bar too high, however, then it’d also be reasonable and healthy for the stock market to pull back from its current levels. We may find other reasons to excuse poor stock market performance if things unravel from here (restrictive monetary policy, oil prices, etc.). But – in the long run – stock prices generally reflect the health (or lack thereof) of corporate earnings.

How does the set up for corporate earnings compare to prior stock market cycles? In the chart provided by 3Fourteen Research below, it’s actually very common for EPS (earnings per share) growth to be flat or down following a bear market bottom (a scenario we just lived through). It’s also common for EPS growth to stage a dramatic comeback after a new bull market is well underway.

Over the next few quarters, we’ll find out if the earnings bar has been set too high (or too low) for corporate America this time around.

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