Lower earnings forecasts from analysts can actually be a positive sign for the stock market, as they can help manage expectations and prevent volatile market reactions when companies report their actual earnings.
Two things can be true at the same time, even if they seem to contradict each other. A prime example of this paradox is currently unfolding on Wall Street. Analysts are continually lowering their profit forecasts, yet the stock market remains robust. This dynamic is significant because, for the past year, earnings estimates have been decreasing due to higher interest rates putting pressure on spending for businesses and households, consequently impacting corporate profits.
The S&P 500’s aggregate earnings per-share estimate has declined by about 10% to $244 from its peak of nearly $250 in early 2022, dragging down 2024 estimates, as per FactSet data. Slower revenue growth, elevated product costs, and increased employee pay have all led to lower profit margins and bottom-line dollars. This, in turn, has resulted in reduced cash flow for share repurchases, further stressing EPS.
Initially, this combination caused a significant drop in stock prices. However, the index has since rebounded and is now at over 4500, only 26% below its record high. The market is on an upturn as there is optimism that the downward trend in EPS forecasts is coming to an end, and profits are expected to resume growth.
However, one last hurdle remains. Earnings estimates are likely to drop even further over the next few months. History shows that fourth-quarter estimates typically decrease by an average of 8% from February to the year-end. Although this year they’re down 6% since February, lower fourth-quarter estimates would signal a decline in this year’s EPS and subsequent profit dollar estimates for next year.
The anticipated deceleration in economic growth and the cautious outlook given by several companies on their earnings calls indicate that more downward revisions of EPS estimates are on the horizon. Nevertheless, this should eventually stabilize forecasts.
The coming deceleration in economic growth is expected to stabilize once interest rates are done rising, and companies may give a less gloomy outlook next year. This could lead to modest beats of conservative EPS expectations and eventual profit growth.
This growth is particularly anticipated in the technology and healthcare sectors, which are expected to drive a significant portion of the S&P 500’s earnings growth next year.
In conclusion, the market is poised to continue its upward trajectory despite ongoing downward revisions of profit forecasts. This is made possible by investor confidence in the projected growth of earnings and the anticipation of estimates bottoming out. As long as this confidence persists, the stock market is expected to keep climbing.