By Tim Courtney, Chief Investment Officer
Despite being a fundamental factor in market performance, news on earnings has been surprisingly quiet over the past three years as shutdowns, supply chain issues, inflation, labor shortages and crypto speculation took center stage. We can mainly attribute this period of earnings neglect to the market’s utter fixation on interest rates and decisions by the Federal Reserve (Fed) to raise them at a historic pace.1
Even as earnings saw a significant surge in 2021 followed by a decline last year, market prices were still being mostly driven by interest rate expectations. It is important though to recognize that earnings and cash flows are the fundamental reasons we invest in markets, so it is a good idea to check in and see where we are with earnings overall.
Within the graph above, earnings growth averaged about 5%-6% 2 for decades, and then in 2021 they suddenly spiked 2 Earnings moved well above the long-term trend because distortions were emerging in the market post-pandemic, as a result of loose fiscal and monetary policies implemented by the government and Fed. Unfortunately, that spike in growth wasn’t sustainable, and recent earnings have settled lower. One other point to make before we move on from the graph – notice the years leading up to 2007 – the other time that earnings moved well above trend line. That market had been distorted by earnings from Financials and the leveraging of mortgage debt.
In conjunction with earnings and 0% interest rates, the market also surged higher in 2021. But stock prices came back down in 20223 as growth slowed and inflation peaked. Earnings have been fading recently and could continue to fade regardless of whether we experience a recession or not, since profits will likely settle closer to a more sustainable long-term trend.
Now that the majority of the move higher in interest rates has been completed, the market will likely overcome its interest-rate obsession and begin focusing on earnings and the profitability of companies again. Those companies that are highly priced and have trouble maintaining their earnings will be under pressure. Conversely, the market may be more forgiving toward companies whose stock prices are lower because they didn’t surge higher in 2020 and 2021. Those companies have a lower bar to clear.
As we are in the middle of Q1 earnings for 2023, earnings expectations for the full year are all over the map. On average, the S&P companies are expected to eke out growth for the year. So far, earnings reports have been quite strong. We could though find that aggregate earnings for the S&P will fall somewhat to align with the long-term trend, recession or not. Either way, the market is getting healthier and moving away from distortion and back into fundamentals. If you have any questions, please contact your Exencial advisor.
- The New York Times (3/7/23) — Fed Chair opens door to faster rate moves and a higher peak
- S&P Global (03/31/23) – S&P 500 Index Operating Earnings, Annualized
- U.S. Bureau of Economic Analysis (2/23/23) — Gross Domestic Product, fourth quarter and year 2022 (second estimate)
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