Stocks Have Rebounded — What About Earnings?

It has been well publicized for months now that leadership for this recent stock market bounce remains narrow. Just last week, RBC posted an article showing that of the 12% year-to-date gain in the S&P 500, the "Big 7" (namely Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla) represents 84.1% of that return. The other 496 stocks in the S&P 500 represent only 15.9% of the index’s return so far this year.

However, stock prices only tell part of the story. I wanted to understand better to what extent these stock gains are justified by changes in earnings expectations.

After analyzing the data, here are some key takeaways I found that I wanted to share:

• From 9/30/22 (roughly the stock market bottom) through 6/16/23, the Big 7 stocks are up a whopping 68% on average (after smoothing out NVDA's exceedingly positive impact on the average, the median Big-7 stock is still up 34%).
• During that same time period (Sept 2022 to current), calendar year 2023 earnings estimates for the Big-7 have decreased by 6% on average (median decline is 10%); and calendar year 2024 earnings estimates have risen by only 1.2% on average (and the median has also declined by 7%). (I used calendar year estimates for all companies to compare apples to apples for companies that were on different fiscal years).
• The only stocks among the Big 7 that have seen their earning estimates go up for either calendar years 2023 or 2024 between these two dates are Nvidia and Meta. All five of the remaining Big 7 earnings estimates were down.
• I think most people would be surprised to hear that, since the stock market bottomed last September, Apple's 2023 earnings estimates have continued to fall another 23% and 2024 estimates are down 3.4% (even though the stock has risen 34% during the same time period).
• I also think most people would be surprised to hear that Microsoft's 2023 earnings estimates for 2023 and 2024 have fallen 6.4% and 9.7%, respectively, yet the stock has rebounded 47% since the market bottom.
• Tesla, whose stock has recouped nearly everything it lost in the second half of 2022 — gaining 155% from its lows — has seen its earnings estimates fall a massive 45% and 36% for calendar years 2023 and 2024, respectively, during this period.
• The median Big-7 stock now trades at 36x 2023 estimates and 29x 2024 estimates, which is amazing since the median earnings estimate has fallen 10.3% and 6.9% for 2023 and 2024, respectively, since the market bottomed in September.
• Median YoY earnings growth expectations for 2024 among the Big 7 remains over 30% — which still seems aggressive given the direction of earnings revisions.
• Meanwhile, the S&P 500 has gained 23% between these dates, yet earnings estimates for the index have fallen for both calendar years 2023 (down 8.3%) and 2024 (down 5.5%).
• At 4,400 on the S&P 500, I calculate the index now trades at 20x 2023 earnings estimates and 18x 2024 estimates.

Is this analysis backward-looking? Perhaps. But either way my conclusion is that we need to see most of these Big-7 companies beating estimates and guiding up in second half of this year or for 2024 to lend support to recent moves in these stocks and turn this into the next leg of a renewed bull market. The current trend of narrow stock leadership from stocks with declining earnings estimates cannot continue. There is certainly no room for guide-downs among the Big-7 stocks heading into this earnings season.

But what about AI? Yes, that buzz has certainly created a lot of optimism and will undoubtedly become a trend with eventual earnings impacts that we will talk about for many years to come. But there will also be costs involved. Few companies have seen this truly materialize into improved earnings visibility to-date.

There is also no confirmation of improved fundamentals across the rest of the S&P 500 (i.e.. ex- the Big 7), which is acting more in line with earnings fundamentals. Year-to-date, you would be better off owning a short-dated Treasury or CD with a yield to maturity of 5% versus owning the rest of the S&P 500 ex- the Big 7.

I remain cautious because the benefits of tight employment have peaked and consumers are still spending far more than they save. I expect job losses this cycle will have much larger negative impacts on consumer spending than in past economic cycles. This is a forthcoming headwind on earnings, though in theory this should be very well understood by financial markets at this point in time. In theory, he says...

Meanwhile, the Fed has said it may not be done after all. This was not expected. Consensus was still holding out for rate cuts late in 2023 just last month. While that hope is all but gone now that Powell and team have signaled for possibly higher interest rates still to come in 2023, consensus is still widely betting on rate cuts in early 2024. I continue to expect a Fed plateau, not a pivot, and they will keep rates at a higher level for longer than anyone currently expects. Therefore the yield curve will remain inverted in the near term. If the shape of yield curve gets resolved, I continue to believe it will be because long rates go up more than short rates come down.

Net-net, the imaginary brakes remain deployed on the broader economy, and earnings estimates have been declining during a period of time where we still haven't even seen any material negative impacts on consumer jobs and spending, or the lagging effects of rising interest rates. Maybe this time will be different, but it is still too early to draw that conclusion based on any data I have seen.

Stocks will always lead the fundamentals. The bull case is that the data above is all history, negative earnings revisions have bottomed, and 30% median growth (or more) that is baked in for these companies is indeed achievable or beatable in 2024. Boy, I hope that's right, but it seems like a pretty big leap of faith in the face of still-concerning macro headwinds.

The set up here for stocks now that the S&P 500 has rebounded off the bottom seems dangerous heading into the second half of this year and early 2024, without more contribution and confidence from corporate earnings, the Fed, and other leading economic indicators. We need a lot more to go right from here than just stock prices.

**All commentary in this article represent my own personal views, opinions, and analysis, and are not representative of those of my current or past employers, nor intended to do so. None of my comments are intended as or should be viewed as personal investment advice, nor am I compensated to provide any of the commentary above.**