*Originally published August 25, 2023
By Tim Courtney, Chief Investment Officer
Over the past few years, a whirlwind of events – catalyzed by the Covid-19 shutdowns – has captured the market's attention, and the headlines have followed suit. From supply chain woes and inflation concerns to the rise of meme stocks, cryptocurrencies and the advent of AI, most of the news focus has skewed away from company fundamentals. There have been relatively few stories on the very reason we invest in companies: earnings.
For decades leading up to 2020, the S&P 500 produced annualized earnings growth of around 6%.1 This growth makes up a good portion of stocks’ future expected return. The pandemic-induced shutdowns of 2020 naturally impacted earnings, which were awful and on par with the decrease experienced during 2008-2009. But then measures by the Federal Reserve (rates to zero) and government (check writing) sparked a surge in earnings. By the end of 2021, the S&P 500 boasted a leap to $208 in operating earnings.2 In 2022, when rates were rising and check writing somewhat slowed, we saw earnings fall to around $1971 but still well above that 6% long-term growth trendline. This year, we’re still waiting to see where the numbers land. Will we recede deeper toward the trend line, rebound back up and establish a new level?
First-quarter earnings results sent markets cheering,3 setting an optimistic tone for 2023. So far this quarter, with over 90% of companies having reported, results have appeared relatively favorable. As of August 20, 76% of firms have exceeded earnings expectations,4 although it's important to note that these expectations had been lowered going into 2023.
If companies are able to keep up this pace, the S&P 500 will set a new earnings record, surpassing the prior record set in 2021. So far this year, the stock market pricing seems to indicate that investors believe earnings will remain strong and that we have established a new earnings level above our previous trend line.
There are still some variables that could give pause to investors. Interest rates are high and have been climbing, and the Fed’s goal is to slow down inflation by slowing growth. If that occurs, it will almost certainly have an impact on earnings. Or if growth doesn’t slow sufficiently to contain inflation, we may find that elevated inflation becomes more embedded in the economy – which will, in turn, reduce our real return.
While a recession may not necessarily be on the horizon and GDP may continue to be positive, risk, as always, remains. And with interest rates being where they are, investors who believed “There Is No Alternative” to stocks in 2021 may start to find there are actually alternatives today paying 5%. In other words, you typically don’t pay as much for an asset when interest rates are higher, even if earnings are healthy. That is why we are disciplined about the assets we are invested in and the prices we pay for them. If you have any questions, please contact your Exencial advisor.
- YCharts (data as of 8/16/23) — S&P 500 operating earnings per share
- FactSet (3/11/22) — S&P 500 earnings season update: February 11, 2022
- Yahoo! Finance (3/31/23) — Stocks surge to cap first-quarter rally: Stock market news today
- The Wall Street Journal (8/12/23) — Stock rally stalls despite better-than-expected earnings season
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