3 Drivers of Earnings Recovery
2023.09.12 04:46
Valuations have driven all the stock market returns this year. Now the focus is on recovering earnings to drive the next leg of the bull market.
These are being driven up by tech leadership, stabilizing profit margins, and economic resilience. They are led by the double-digit profit estimate increases over the past three months by the semiconductor, retail, and consumer industries, whilst banks and pharma have been the notable decliners. These positive earnings increases have been global, with the US outpaced by markets as diverse as Korea, Japan, India, Italy, and Spain, with the UK, Australia, and China among the few country decliners.
The earnings upturn has triple drivers.
1) Tech leadership
The biggest stock market sector has seen a 5-point upturn in profit growth forecasts in the past three months, led by semiconductors. Tech was the first sector to feel the post-pandemic hangover, to cut costs, and is now benefiting from AI growth.
2) Profit margins
The producer price deceleration has outpaced the headline inflation slowdown. This has started to take pressure off corporate profit margins.
3) Economic strength
The economy has been much more resilient than feared, led by the consumer, and has pushed back recession fears. The number of S&P 500 companies mentioning ‘recession’ or ‘inflation’ on their conference calls has continued to fall (See chart).
Q3 earnings season starts Oct. 13th and is the next test. Profit expectations have been surprisingly rising and are now back into positive territory on a year-on-year basis. This would mark the end of the nine-month earnings ‘recession’.
This estimate turnup is the opposite of normal and another sign of the fundamental ‘triple’ improvement underway. S&P 500 estimates have historically cut an average of -4% into earnings season, setting up companies to beat lowered expectations and giving US stocks their typically world-leading ‘beats’ rate.
Falling macro risks
