The S&P 500 has rallied nicely over the last couple of months, and now the debate on whether the rally can continue is on. Most analysts seem to think that it isn’t sustainable, and well-known economists David Rosenberg of Gluskin Sheff said recently that he doesn’t really see why U.S. equities have been rallying. Also Lindsey Bell of S&P Global Market Intelligence warns that the recent improvement in earnings per share might not be sustainable, basing her view on historical changes in earnings estimates.

However, some analysts think the markets are being too pessimistic. In fact, Morgan Stanley analyst Adam Parker also looked at historical changes in earnings estimates and drew the opposite conclusion of Bell.

A contrarian call on S&P 500 earnings

Adam Parker, known for his contrarian and at times offensive to winners (see this post where he referred to investors who have been able to win in the difficult market conditions as “cockroaches”), is calling for a 4% increase in earnings for the S&P 500 in 2016. He offered some explanation in his June 13 report titled “Turn a Lemon Into Furniture Polish or Clean Furniture with Lemonade?” He notes that his estimate hasn’t changed since the broad-based market selloff in February and defends his lack of increased pessimism now.

This is quite a contrarian view as S&P Global Market Intelligence Senior Analyst Lindsey Bell reports that consensus calls for only 0.32% growth in earnings for the S&P 500 right now. Further, expectations have slid dramatically since January:

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Consensus views on second quarter earnings for the S&P 500 have also tumbled since the beginning of the year:

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S&P 500 earnings estimates are too low, says Parker

Parker bases his view that the S&P 500’s rally will continue on his expectation that earnings estimates for the next few quarters are too low. He also thinks the low- to mid-single digit growth in the index’s earnings could “continue well into 2017. As a reference, here’s a look at the consensus estimates for growth in earnings for the S&P 500 in the third and fourth quarters according to S&P Global Market Intelligence:

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Consensus also expects a strong rebound in 2017:

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A history of earnings estimates

Parker did some work similar to what Bell did earlier this month, although he took a different angle and used slightly different data. And he came up with the opposite conclusion to what she said. According to Bell, her analysis of historical changes in earnings estimates (view the entire report here) “suggests that the recent improvement in S&P 500 calendar year earnings-per-share could be temporary in nature.” Bell also observed that during and after times of economic stress, earnings growth has been hard to predict, and thus estimates “can move erratically.”

But according to Parker, in 34 of the last 40 years since bottom-up earnings estimates have been circulated, first-half estimates for the full year were two high. The six times when they were two low were during periods of recovery from a recession or in the year after the recovery.

“So, the limited history of under-optimism by bottom-up analysts is associated with a lagged effect of a fresh recession, causing analysts in aggregate to be too bearish exactly at the wrong time,” Parker explained.

Parker added that over the last 40 years, the average consensus estimate at this time of the year called for a 9% increase in earnings for the S&P 500 for the full year. However, right now the consensus stands at about 0% growth, as noted above. Parker called expectations “clearly atypically low right now,” although he also noted that of course market conditions change every year. He also thinks Energy sector earnings will outperform expectations this year because he thinks the consensus is following past behavior of being too bearish following the energy earnings recession.

So who is right? Only time will tell whether more volatility is ahead or whether it will be a smooth ride sooner rather than later.