The corporate earnings season for the first quarter is nearly complete, and investors appear focused on these earnings announcements even more than usual due to ongoing economic uncertainty amid high inflation, slower growth, and the banking crisis. In this context, corporate profitability can shine a spotlight on how companies, sectors, and the broader economy are truly faring in this environment. Further, focusing on earnings trends is a way to cut through the day-to-day noise of the stock market and news headlines.
We discuss in this episode of The Wealth Effect Podcast:
📊 The Stock Market & Earnings
🎛️ Sector Earnings & Valuations
🧮 Stock Market Valuation Measures
Matt Faubion, CFP®
Founder - Wealth Manager
Show notes and charts:
In the long run, markets tend to follow earnings
While a recession may not be pre-ordained, the economy is largely expected to remain flat throughout 2023 before rebounding in 2024. Not surprisingly, the same is true for earnings expectations after significant downward revisions last year. Current consensus estimates suggest that S&P 500 earnings will be flat this year at around $215 per share before rebounding by 12% next year. While these forward-looking estimates should be taken with a grain of salt, both the economic and earnings projections suggest that 2023 will be a reset year before a "v-shaped" recovery occurs. Whether this happens will depend on factors such as inflation, the labor market, and monetary policy.
Most sectors are expected to experience positive earnings growth
The specific circumstances also differ significantly across individual companies and industries. At the moment, it's positive that seven of the eleven S&P 500 sectors are expected to experience earnings growth over the next 12 months. This includes sectors such as Information Technology, Communication Services, and Consumer Discretionary, which are facing near-term struggles with the tightening rate environment. Information Technology experienced a 15% decline in earnings last quarter, concentrated in Semiconductors, but these figures suggest that this could turn around later this year. In contrast, Consumer Discretionary experienced the largest year-over-year earnings growth this quarter (36% according to FactSet) and some of the largest positive surprises as well. However, remember that this sector is primarily dominated by Amazon, which is more broadly a reflection of the retail sector.
Valuation metrics have risen due to slowing earnings growth
What does this mean for the overall market? Flat growth this year makes valuing the stock market tricky. For valuation metrics with earnings, sales, or cash flow in the denominator, slower earnings growth makes the market appear more expensive, especially when stock prices have recovered as they have. However, valuation levels will slowly normalize if the economy and earnings rebound next year as the market expects. For now, many valuation metrics remain below historic peaks but still higher than average.
The bottom line: Earnings growth is expected to be flat this year, yet specific sectors have had positive surprises. The broad earnings picture is essential to investors since, in the long run, the stock market follows the earnings trajectory.
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