Stocktake: Investors’ earnings expectations are rising

When it comes to earnings season, expectations are everything.

Rising stock prices mean the S&P 500 now trades on 19.5 times forward earnings, compared to under 17 at the end of 2022. FactSet data shows valuations are now above the index’s five- and 10-year averages (18.6 and 17.4, respectively).

“That makes the set-up for the current earnings season materially different than the last one in that investor expectations are substantially higher,” notes market strategist Charlie Bilello.

This could be seen in the market reaction to Netflix and Tesla, says Bilello, with both stocks comfortably beating estimates only to suffer sizeable declines in the days after their reports. In contrast, Bilello notes expectations were much lower for bank stocks heading into earnings, with one ETF tracking US financial stocks falling 19 per cent in the first half of 2023. That set the scene for a nice rebound, with the fund gaining 18 per cent over the last month.

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These are not isolated incidents. Thus far in earnings season markets are rewarding positive earnings surprises less than average, notes FactSet. Counter-intuitively, investors are rewarding companies that seemingly flop on earnings.

Ordinarily, companies that miss estimates suffer an average fall of 2.2 per cent. Currently such stocks have actually gained an average of 1.4 per cent. Clearly, a lot of good news was priced into high-flying companies, and a lot of bad news was priced into market laggards.

To repeat: when it comes to earnings expectations are everything.