S&P 500 Earnings and Estimates Decline as Stock Prices Soar

by the Curmudgeon

The Question:

Do earnings drive stock prices?  That’s the conventional wisdom.  Turner Investments certainly believes it as per a blog post:

“We believe earnings drive stock prices. We think our belief is confirmed by our recent research that shows earnings growth is a persistent phenomenon that can lead to higher share prices.”

As for earnings expectations as measured by analyst estimates, an AAII article titled: Earnings Estimates and Their Impact on Stock Prices states:

“Earnings estimates are an important element for you to keep in mind when you analyze and select stocks. They are a numerical view of expectations, and changing expectations drive stock prices.” 

Is that really true?

The Evidence: 

We’ve noted in two recent Curmudgeon posts that 2nd Quarter 2016 will mark the fifth consecutive down quarter for S&P 500 blended earnings (Source: FactSet).  Here is the most recent FactSet update:

“As of July 22nd the blended earnings decline for the second quarter for the S&P 500 stands at -3.7%. Factoring in the average improvement in earnings growth during a typical earnings season due to upside earnings surprises, it still appears likely the S&P 500 will report a year-over-year decline in earnings for the second quarter. If the index does report a year-over-year decline in earnings for the second quarter, it will mark the first time the index has reported five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009.”

What’s more, analysts now believe S&P 500 corporate earnings will decline AGAIN in the third quarter of 2016 as can be seen from the chart below: 


What’s interesting is that the DECLINE in Q3-2016 earnings expectations from 3.3% on April 1, 2016 to -0.25% on July 22, 2013 was coincident with an exceptionally strong stock market rally.  Here are then numbers:

On April 1st, the S&P 500 opened at 2,056.62 and closed today (July 26th) at 2169.18.  That’s an increase of 5.47% or ~20% per annum (not including dividends).  FactSet notes that analysts in aggregate do expect earnings growth to return in the fourth quarter of 2016. 

Here are comparable figures from Thompson Reuters, received via email from USA Today’s Adam Shell: 

S&P 500 Blended Growth Rates




























 Source: Thomson Reuters I/B/E/S

Note:  Earnings and revenues for 2016Q2E through 2016Q4E are being updated today by Thomson Reuters.


Earnings as a Lagging Stock Market Indicator?

In a provocative blog post titled: Trading Earnings Through the Year View Mirror, Charlie Bilello of Pension Partners makes the case that earnings are a LAGGING indicator for stock prices.

“By the time earnings data is released on the prior quarter, the market is already looking ahead to the future. When the future stops looking like the prior quarter, problems arise when it comes to timing your exposure to stocks. Specifically, when earnings have been negative (a sell signal) but turn positive, investors often miss out on gains. They also miss out when earnings go down but stock prices continue to rise (yes, this can happen as we have seen over the past year and a half).

If earnings are not a leading indicator, why do we focus on them so much?  For the same reason we focus so intensely on the jobs report, another lagging indicator. Earnings lend themselves well to storytelling, at the macro level about the broader market/economy and at the micro level about companies themselves. We all love a good story, so earnings information is always front in center in the market news flow.”

Bilello writes that “S&P 500 earnings have declined on a year-over-year basis for six (not five) consecutive quarters, the longest downward spiral since the 2007-09 recession.”  He also includes this chart:



Charlie’s conclusion is somewhat baffling, as it assumes that “investors” should be better at forecasting future corporate earnings than high paid analysts! Here it is (Emphasis and additional question marks added):

“The resiliency of the market today likely tells you market participants are looking ahead to higher earnings to come, and we are already seeing signs of that this quarter.   The lesson for investors is clear. Earnings only tell you what has happened, not what will happen. Investing, of course, is all about what will happen. On the road to investment success, spend more time focusing on the dirty windshield (???) than the clear rearview mirror.

Other Opinions:

Source: “What Advisors Are Saying About Earnings Season

·       Ed Butowsky, managing partner at Chapwood Capital Investment Management, said, “It's amazing that stocks are at these record levels, but with all the negative earnings coming in, it doesn't make sense, because at some point there will have to be a reversion to the mean. Just because stock prices are going higher doesn't mean you continue to ignore the valuations.”

·       Brian Koslow, the president of Clarus Financial stated, “I'm growing very cautious of the market at these levels. Investors are chasing yield without giving much thought to the risk profile of higher yielding investments. In the end, corporate earnings are the thing that will drive stock prices.”

·       Rose Swanger, the principal at Advise Financial, said, “Unless you're a long-term investor who has taken advantage of the past market dips, this is not an ideal buy-and-hold environment for near-retirees. The overpriced equity market, in conjunction with the negative earnings, creates uncertainty and volatility.

End Quote:

We end with a quote that best summarizes our current views on this topic.  It's from Kristi Sullivan, the owner of Sullivan Financial Planning:

“Four (five, or six?) consecutive quarters of negative corporate earnings seem like a bad thing. But it is possible that the stock market reacts in no predictable way to news, numbers or prognostications.”

Good luck and till next time...

The Curmudgeon


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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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