The reporting season that has just started will once again exceed some expectations and fall short of others. But one thing we expect for sure is that stock analysts and strategists will reliably point out that this time it's less about the numbers actually reported and more about the company outlooks.
Clearly, the stock market trades the future, not the past. And rarely is the future more difficult to capture in figures than at times of major cyclical swings. As our Chart of the Week shows, there are two typical patterns in the development of earnings estimates over time.
Sources: Refinitiv, DWS Investment GmbH as of 7/14/21
Since the beginning of this year alone, 2021 earnings estimates for the Stoxx 600 have been raised by 13%, and for the S&P 500 by 15%.
First, consensus estimates (their compilation starts around two years before the beginning of the respective year) are always far too optimistic in the beginning. That's human nature: we tend to assume things will get better in six to twelve months. Second, the dynamics of upswings and downswings are regularly underestimated. For example, a long way into the fall of 2009 analysts still had to revise their estimates for the same year downwards sharply, while 2010 estimates were revised upwards well into the fall of 2010 to keep up with the recovery.
This is also clearly evident in the current upswing. Since the late fall of 2020, with vaccine approvals, the Democratic victory in the U.S. presidential election and a swiftly improving economy, analysts have had to adjust their 2020, 2021 and 2022 forecasts upwards. Since the beginning of this year alone, 2021 earnings estimates for the Stoxx 600 have been raised by 13%, and for the S&P 500 by 15%. Prices have actually rallied about 18% for both indices over the same period, which in turn means that markets have become more expensive, measured by price-to-earnings ratios. This was certainly not a given, as bond yields have risen from -0.6% to -0.3% for 10-year German government bonds and from 0.9% to 1.4% for 10-year U.S. Treasuries since the beginning of this year.
That prices are running ahead of estimates is, in turn, almost self-evident. First, because the direction of the market influences the analysts' assessments. Second, because estimates are neither revised nor collected on a daily basis. The fact that the reported consensus thus usually lags behind actual expectations is evident again this quarter. For example, the consensus for quarterly earnings for the S&P 500 is $45, according to Bloomberg. But we think anything below $50, the so-called "whisper estimate," would be a disappointment. Also, the fact that so many market participants are assuming a "beat" quarter, i.e. an over-fulfilment of expectations, suggests that the market would not be positively "surprised" at all by such results.
In the end, all these tactical market games should not obscure the fact that, in the long term, share prices are geared to reported earnings, much of the rest is noise.