Earnings Are Boosting Stocks, Even When They Stink

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Companies that have reported profits are outperforming the broader market so far this earnings season.

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Even shares of companies whose profits fall short of expectations are performing well after they report their earnings. It’s a good sign for the stock market.

The second-quarter results that have landed so far have largely beaten expectations. Companies accounting for about 11% of the S&P 500‘s
Market capitalization had reported earnings through Monday, and about 64% of those earned more than anticipated.

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Both companies that beat earnings forecasts and those that didn’t are outperforming the broader market. Including all the results through Monday, the average stock-price move among companies that had reported outperformed the S&P 500 by 1 percentage point, according to Wells Fargo. Shares of those that missed beat the index by 0.8 point.

That is a sign that the stock market might be ready to move upward. The reason stocks are even gaining on poor earnings results helps to explain why.

With the S&P 500’s 19% decline from the record high it hit in January, the market has already reflected much of the damage to the economy and earnings that could result from the Federal Reserve’s efforts to fight high inflation by reducing liquidity in the bond market and raising short-term interest rates. Those moves are meant to dent economic demand, which will also reduce corporate earnings. Higher rates on long-dated bonds make future profits less valuable, thus lowering stock valuations.

The S&P 500 is now trading for around 16 times the aggregate per-share earnings its component companies are expected to produce over the next year, down from just over 20 times to start the year.

That, in turn, means that stocks can perform well even after disappointing earnings. As earnings season has gotten under way, the S&P 500 has posted a gain of just over 1%. Valuations are so low now, reflecting expectations that earnings will slip, that investors are willing to buy stocks even if profits miss forecasts, as long as the results aren’t disastrous.

Of course, Wall Street’s estimates of earnings are likely to decline even further. The aggregate 2022 earnings per share estimate for S&P 500 companies has risen a touch this year, while dangers to the economy have emerged. Profit forecasts are likely to fall to reflect those risks. The consensus 2022 EPS estimate for the index is already down 0.3% in the past month, according to FactSet. If the drop in estimates is large enough, the stock market could drop from here.

Whether forecasts drop a lot or a little, though, the stock market is reflecting at least much of the damage. “A good deal of the expected [profit estimate] declines have been discounted,” writes Dennis DeBusschere, founder of 22V Research.

It isn’t that the stock market can’t fall considerably further, but the larger part of the slide may be behind us.

Write to Jacob Sonenshine at [email protected]

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Credit: www.marketwatch.com /

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