What the hell is going on with earnings? 😵‍💫

Stock market pros have doubts about gravity-defying expectations 💸

(Source: Getty Images)

Strategists across Wall Street are trying to answer: What’s going on with earnings?

It’s a critical question. As TKer readers know, earnings are the most important driver of stock prices in the long run.

You’d think with all the bad news about inflation, all the talk about recession risks, and all the worries about the impacts of tighter monetary policy, the earnings outlook would have been deteriorating for months.

But it hasn’t.

According to FactSet data through June 17, analysts estimated S&P 500 earnings to grow 10.4% year-over-year to $230.52 per share in 2022. This reflects upward revisions over the past year. Even with intensifying recession concerns in recent months, these estimates reflect an improvement since March 31, when analysts were estimating 9.6% growth.

(Source: FactSet)

There’s a lot to be said about this situation.

For starters, expectations for earnings growth are not uniform across industries. For instance, the S&P 500 has significant exposure to the energy sector,¹ and earnings for those stocks are expected to surge 118% year over year thanks to higher energy prices. This helping to prop up expectations.

(Source: FactSet)

It’s important to note that despite surging energy prices, demand for energy has been almost shockingly resilient. According to AAA, the national average gas price was $4.955 a gallon as of Wednesday, up 61% from a year ago. However, weekly EIA data through June 15 show demand is essentially unchanged from a year ago.²

This speaks to the strength of consumer and business finances, which have enabled consumers and businesses to pay up for higher prices. This phenomenon has been occurring across all industries, as reflected by robust profit margins during this period of high inflation.³

“Maybe inflation is why estimates are holding up so far,” Jurrien Timmer, director of global macro at Fidelity, suggested in a tweet on Thursday.

Timmer shared the chart below showing how analysts’ earnings estimates evolved over time for various years.

“This chart illustrates that nominal earnings growth often holds up well during periods of high inflation (1940s & 1970s),” Timmer said. “So, it’s not a given that earnings are about to crater.”

This speaks to the idea that stocks can act as a hedge against inflation since the underlying companies are the ones raising prices in inflationary environments.

Zooming out a bit, pricing increases are among the broad array of actions that businesses are able to take quickly in their efforts to preserve and grow profitability amid challenging business backdrops. And if there’s one thing we’ve learned from the pandemic it’s how incredibly resilient and remarkably adaptable businesses can be. It’s why it can be “dangerous to underestimate Corporate America.” It’s a good reason why analysts haven’t cut their earnings estimates.

That said, corporations can only do so much before an economic downturn inevitably erodes profits.

Experts warn about what could be next for earnings

Earnings are clearly top of mind. Almost every equity strategist’s research note⁴ that hit TKer’s inbox this week explored what could happen with expected earnings (aka forward earnings).

Let’s go through some of their observations.