The fear of a peak in corporate profits is one of the most cited explanations for the stock market’s lackluster reaction to the best earnings season in years.
But even if the market just witnessed peak earnings, it doesn’t mean the end of the bull market is imminent, said Sam Stovall, chief investment strategist at CFRA, in a Monday note.
According to FactSet, with more than 80% of S&P 500 companies having reported earnings, the blended, year-over-year earnings growth rate for the first quarter is 24.2%, based on actual results for companies that have reported and analyst estimates for those yet to report.
For the rest of the 2018 and 2019, however, earnings are expected to moderate, Stovall noted (see chart below).
“The better-than-expected growth in Q1 [earnings per share] for the S&P 500 was being viewed as both good and bad for this aging bull market,” wrote Stovall, adding that it explains “investors’ indecision.”
Indeed, shares of companies that beat expectations have reacted slightly negatively two days before and two days after the earnings release, while earnings that disappointed were punished more harshly than usual.
The S&P 500
is up less than 1% since April 13, when the earnings season unofficially kicked off with results from large banks and is up just 0.2% for the year to date, having largely moved sideways after an early February tumble that pushed it and the Dow Jones Industrial Average
into correction territory as both fell more than 10% from records set in late January.
Stovall, in the chart below, looked at historical 12-month rolling earnings data and found that “in more than 70% of observations since WWII, the S&P 500 rose in price nine months after a peak in 12-month GAAP EPS growth.” GAAP is an acronym for generally accepted accounting principles.
But what about the 30% of observations when a peak in earnings does mark end of a bull market? Is it possible that the current peak in earnings will turn out to be a harbinger of peak in the business and economic cycle, like in 2006?
Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets, doesn’t think so, noting that consensus estimates are still pointing to earnings growth rather than contraction over the next few years.
Consensus estimates should be taken with a grain of salt, however, as analysts can and often do revise their forecasts when prices change.
“Our latest read on the growth rates implied by [consensus] estimates indicates that the peak in the growth rate for S&P 500 occurred in the first quarter of 2018,” Calvasina said in a note.
“If first-quarter turns out to be the peak in S&P 500 earnings-per-share growth, then recent equity market weakness makes a lot more sense,” said Calvasina, adding that the stock market tends to be weak in the short term after a peak in EPS growth.
But longer-term returns depend on whether the latest growth rate in earnings qualifies as early-cycle or late-cycle peak.
“Following the 1999 and 2006 late-cycle peaks in EPS growth, the S&P 500 was higher 6 and 12 months after the peak in EPS growth occurred. The index eventually ran into trouble and was down 24 and 36 months later,” Calvasina wrote (see chart below).
In 1999 and 2006, earnings growth plunged after peaking, turning outright negative. But Calvasina doesn’t see that outcome over the next 18 months.
“There are no perfect historical examples, but the trajectory of EPS growth in place for 2018–19 most closely resembles 1993, 2004, and 2009, when EPS growth moderated after peaking but never moved into negative territory. In those instances, stocks were down six months after the peak but were higher 12 months later,” she said.