It’s Been a Strong Earnings Season, So Why are Markets Down?

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Last week, FactSet (NYSE:FDS), a company that provides data on market analytics, issued a report saying that this current earnings season for the quarter that ended on March 31 (for most companies) is on track to reach the highest average earnings growth rate in two years.

However, the strong earnings season has had little impact on the markets, as the S&P 500 has dropped 1.3% since April 1, while the Nasdaq 100 is off by about 1% since then. Thus, many investors may be wondering why the strong earnings results haven’t correlated to market returns.

Best earnings growth in two years

The FactSet report revealed some interesting data about this earnings season so far. As of May 3, 80% of S&P 500 companies had reported results, and of that share, 77% have beaten earnings estimates. That is equal to the five-year average but above the 10-year average of 74%.

On average, S&P 500 companies post earnings results that are 7.5% above estimates, which is below the five-year average of 8.5% but better than the 6.7% average over the last decade. Eight of the 11 sectors are reporting year-over-year earnings growth, with Communication Services, Utilities, Consumer Discretionary, and Information Technology leading the way. Only Energy, Health Care, and Materials are reporting a year-over-year decline in earnings thus far.

Overall, the projected earnings growth rate for the first quarter — estimating the results of the approximately 20% of companies that have not reported yet — is expected to be 5%. If the 5% rate holds, it would be the highest year-over-year earnings growth rate for the S&P 500 since the second quarter of 2022, when the index’s earnings rose 5.8%, according to FactSet.

Revenue results are not quite as strong, as 61% of S&P 500 companies have reported revenue above estimates. That is below the five-year average of 69% and the 10-year average of 64%. Further, companies are reporting revenue in aggregate that is 0.8% above estimates, which is also below the five-year average (2%) and the 10-year average (1.4%).  

Additionally, eight sectors have posted year-over-year growth in revenues for Q1, led by Communication Services and Information Technology. Three sectors, including Materials and Utilities, are reporting a year-over-year decline in revenue. Overall, the anticipated revenue growth rate for the quarter is 4.1%.

The lower revenue and higher earnings growth likely reflect the widespread expense management plans that large companies undertook last year following the bear market. Nonetheless, the numbers have been pretty impressive thus far and may continue.

More earnings estimates raised for Q2

On May 6, FactSet released an analysis of earnings in the current quarter. Specifically, it looked to see if more analysts were lowering their earnings estimates for Q2, given the economic slowdown in Q1.

The firm found that not only were analysts not lowering their estimates, but they were actually increasing them. In April, the median Q2 EPS estimate for companies in the S&P 500 increased by 0.7% to $59.64.

According to FactSet, this is unusual, not only because of the current macro environment but also because analysts usually reduce earnings estimates during the first month of a quarter.

For example, over the past 20 quarters (five years), the average decline in the median EPS estimate during the first month of a quarter has been 1.9%. During the past 40 quarters, the average decline has been 1.8% in the first month of the quarter.  

In fact, this is the first time since the fourth quarter of 2021 that the median EPS estimate increased during the first month of a quarter.

Where are the returns?

So why is this earnings strength not translating into market returns? There are probably two major reasons. First, the S&P 500 has been on a five-month hot streak and is in the midst of a bull market that has been charging ahead since the end of 2022. Stock valuations have run hot, and the April pullback was probably a reaction to that somewhat.

The current price-to-earnings ratio of the S&P 500 is 22.6, up from 18.4 a year ago. According to FactSet, the forward 12-month P/E ratio is 19.9, which is higher than the five-year average of 19.1 and the 10-year average of 17.8.

The markets have also reacted negatively to the likelihood that the Federal Reserve won’t lower rates as soon or as often as was previously projected. Many investors were hoping for rate cuts to start as early as June and were expecting three cuts this year, but neither of those situations is likely to happen, as inflation has gone sideways this year.

However, while inflation is not down to the Fed’s target range of 2%, it is much lower than it was a year ago at 3.5% or 2.8%, depending on which gauge you use.