Stock Bulls bet everything on profit expectations with a troubled record

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You are never sure what the income seasons will yield. Hence their volatility. But one thing is certain about the first quarter results to be released soon. They mattered no less to current market valuations.

And while it is a Wall Street cliché that “guidance is the most important,” that view is currently being taken to an absurd degree as the S&P calculates 500 gains that are practically impossible to realize in two years. That is a level of confidence in the future whose history provides little basis for justification.

Here’s the math. Based on analysts’ existing earnings forecasts for all of 2021, the S&P 500 is trading at nearly 24 times the estimates, one of the highest on record. To reduce the multiple to the long-term average of 16 times annual earnings, companies in the gauge will need to earn about 15% more than stock researchers currently expect – by 2023.

Is that possible? Yes. Using a compound forecast growth from 2019, it falls within the roughly 6% growth rate in revenues generated by S&P 500 companies over time. But is there any strong reason to suspect that someone has a convincing opinion about what will happen in a specific two-year period? That is darker. Given how much of that view rests, investors would be wise to consider what the market is currently demanding.

“What we’re talking about in mathematical terms is really a psychological phenomenon,” said Lawrence Creatura, a fund manager at PRSPCTV Capital LLC. “It is mathematically observable that the market has more downside than in March 2020, although it is ironic enough feels exactly the opposite.”

Indeed, investors donate one record amount of fresh money in stocks this year amid hopes that vaccines and policy support will bring the economy back to normal. Their willingness to pay for profit has driven the S&P 500’s P / E ratio nearly 20% above its peak during the last bull market. Not that valuations are good timing, but with so much optimism priced in, the risk that these estimates won’t materialize is more dramatic.

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Hypothetically, if earnings don’t catch up and the multiple return of the market is “back to normal” – the long-term average of 16, the S&P 500 is in danger of losing a third of its value.

“Revenue is critical and you really need to focus on that right now,” said Jeff Mills, Bryn Mawr Trust’s chief investment officer. “Unless you keep seeing fundamentals, you could see a dramatic price revision.”

Complicating matters are the Covid-19 pandemic and Wall Street’s massive fiscal stimulus models. It does not matter from 2023: even getting a grip on this year’s results is proving difficult. Go through analysts studying individual companies, S&P 500 earnings will grow 26% this year to $ 174 per share. Ask top-down strategists who make predictions by tracking macro indicators, such as production and a there is a wide range: $ 152 to $ 202 per share.

Even if you got to the top of the strategist range, stocks would trade more than 20 times earnings.

The huge gap is due in part to an environment where no one, a year after the pandemic, can confidently predict the enduring power of demand for stay-at-home, or the boost to consumer spending from stimulus controls. The size of the profit from the supply chain disruptions and rising resource costs are also big jokers.

Banks, including JPMorgan Chase & Co. and Citigroup Inc., will begin reporting next week. First-quarter earnings of S&P 500 companies are expected to grow 24%, the fastest since 2018, according to analyst estimates compiled by Bloomberg Intelligence. Front runners are car manufacturers, retailers and banks whose revenues are likely to have doubled from a year ago.

Analysts’ track record in estimating earnings has, unsurprisingly, suffered during the pandemic – although the fact that they turned out to be too conservative is grist to stock bulls. They underestimate corporate America’s profitability at an unprecedented 20% average in the last three quarters of last year. In the five years before 2020, they only missed 3%.