Earnings expectations under pressure
The end of another quarter means the beginning of another earnings season. Over the last 18 months, earnings expectations steadily improved and drove the remarkably resilient stock market environment. Unprecedented fiscal and monetary support, along with the gradual reopening of the global economy as the Covid-19 situation improved, caused an inflection in earnings expectations in the summer of 2020.
The last four quarters have not only seen a steady rise in earnings for the S&P 500® Index but also positive revisions to earnings expectations. In some cases, those revisions have been quite strong. For example, the 2nd Quarter of this year saw earnings of $52.80 per “share” for the S&P 500. This represented 87% growth over Q2 of 2020, but was also 36% better than the consensus estimate from a year earlier. For many investors, positive estimate revisions and the low level of interest rates justified elevated stock valuations.
The path of revisions for Q3 earnings has been different. Supply chain issues, input cost pressures and labor shortages have put pressure on company profits. Firms across the industry spectrum, including Sherwin Williams, Nike, FedEx, Costco, GE, 3M, and DR Horton, warned on earnings in their Q2 earnings announcements.
In September, consensus estimates for 3rd Quarter earnings ticked lower for the first time this year. Earnings growth is still expected to be 24% for Q3 on 12% sales growth, but the inflection seen in the above graph is giving investors reason for pause. Earnings estimates for the full 2021 calendar year declined for the first time this year, while estimates for 2022 have leveled off at 9% growth.
Given that the S&P 500 continues to trade at a lofty 20-times forward earnings estimates, the market at present is reliant on a continued strong earnings environment. If most of the current inflation and supply chain pressure prove to be transitory, revisions could resume their upward trajectory. But if stresses continue and rates rise, current stocks valuations will be increasingly difficult to justify.
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