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Earnings estimates keep falling, which might be no problem for stocks: Morning Brief

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Friday, January 20, 2023

Today's newsletter is by Myles Udland, Head of News at Yahoo Finance. Follow him on Twitter @MylesUdland and on LinkedIn. Read this and more market news on the go with the Yahoo Finance App.

Corporate earnings season will be in full swing by the end of next week.

Big banks, airlines, and Netflix (NFLX) have all released results so far. And company-level results often surface compelling commentary on the state of consumers and the economy.

But Wall Street strategists looking at aggregate corporate profits for this quarter and the quarters ahead see one clear through line: Expectations are coming down.

Writing in a note to clients on Wednesday, FactSet's John Butters noted earnings for S&P 500 companies are now expected to fall 3.9% during fourth-quarter earnings season. This would set up the benchmark index for its first aggregate drop in profits since the third quarter of 2020.

And the news doesn't get much better looking further out.

"Looking ahead to the first quarter and beyond, what are analyst expectations for year-over-year earnings? Do analysts believe earnings declines will continue in 2023? The answer is yes," Butters wrote. "Over the past few weeks, earnings expectations for the first quarter and the second quarter of 2023 switched from year-over-year growth to year-over-year declines."

At first glance, a reduction in corporate profits — the ultimate long-term driver of stock prices — might seem like an obvious negative for the stock market this year.

A report from Jeffrey Buchbinder and the team at LPL Research released Thursday, however, suggests near-term earnings drops aren't quite a death knell for current-year stock performance. In fact, quite the opposite.

"In years when earnings fall ... stocks are actually more likely to rise than fall," Buchbinder wrote. "This may be surprising to many of you, but when earnings fall, stocks are more than twice as likely to rise as they are to fall."

Stocks often rally in years S&P 500 earnings decline, data from LPL Research shows. (Source: LPL Research)
Stocks often rally in years S&P 500 earnings decline, data from LPL Research shows. (Source: LPL Research)

And as LPL's chart shows, not only are stocks more likely to rise than fall when earnings are falling, but in years the market is down it is also more likely than not corporate earnings actually rise. (Which is why there are more dots in the bottom-right than bottom-left quadrant.)

"This may seem counterintuitive, but it makes sense when we remind ourselves that markets are forward looking," Buchbinder writes. "The markets generally price in earnings declines well before they happen—maybe two or three quarters ahead. By the time earnings declines are in the books, stocks have moved higher in anticipation of the next earnings upcycle."

And when it comes to the all-consuming question of whether the U.S. economy enters a recession this year or not, Buchbinder thinks the market has already cast its vote.

"This is similar to the explanation for why stocks have historically been little changed, on average, during recessions," Buchbinder said.

"It’s because the big declines tend to come before the recession occurs, in anticipation of the downturn. That is essentially what stocks were doing in 2022 — pricing in a downturn in 2023 from Federal Reserve over-tightening."

What to Watch Today

Economy

  • 10:00 a.m. ET: Existing Home Sales, December (3.95 million expected, 4.09 million during prior month)

  • 10:00 a.m. ET: Existing Home Sales, month-over-month, December (-3.4% expected, -7.7% during prior month)

Earnings

  • Ally Financial (ALLY), Schlumberger (SLB), State Street Corp. (STT), Huntington Bancshares Inc. (HBAN), Regions Financial Corp. (RF), Ericsson (ERIC)

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