Things are looking up for investors. The S&P 500 has risen close to 16% since hitting its low point on Oct. 12, 2022. It won't take too many more positive days for a new bull market to begin.
But remember the old adage about not counting your chickens before they hatch. There's no guarantee that the S&P 500 will continue its winning ways. Actually, there is at least one reason to be skeptical that it will. Here's a big clue that the stock market's momentum could be short-lived.
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An important scorecard
There are multiple factors that determine whether stocks rise or fall. However, we can definitely put earnings near the top of the list. That's why Refinitiv's S&P 500 Earnings Scorecard is important to watch. This scorecard reflects the most comprehensive look at earnings reports of companies in the S&P 500 Index.
One thing especially stands out with Refinitiv's S&P 500 Earnings Scorecard released on Feb. 7, 2023: Companies' earnings are falling. The blended earnings growth-rate estimate for the fourth quarter of 2022 is a negative 3.1%. And the picture is a lot worse -- negative 7.4% -- if the energy sector is left out.
Is it possible for stocks to continue to rise when earnings are falling? Sure. You might have noticed that sometimes a stock will jump after a quarterly earnings report despite posting lower earnings. The trick is that the earnings results must beat expectations.
There's good news and bad news on this front. The good news is that many S&P 500 companies are indeed exceeding expectations. Big companies are reporting earnings results that are, on average, 1.4% above expectations, according to Refinitiv. What's the bad news? This rate is much lower than it has been historically.
Since 1994, earnings numbers for S&P 500 companies averaged 4.1% higher than analysts' estimates. Over the previous four quarters, the average earnings beat was 5.3%. Refinitiv stated that the 2022 Q4 earnings surprise percentage is the lowest it's been since Q4 2008. That was during the market meltdown in the Great Recession.
What matters most
Earnings results truly are key factors that drive the stock market. What matters most, however, are companies' projections of how strong their earnings will be in the future.
This shouldn't be surprising. Investors are forward-looking. The stock of a company with weak recent earnings results but great earnings guidance will almost always outperform the stock of a company with great recent earnings results but weak earnings guidance.
So what does Refinitiv's S&P 500 Earnings Scorecard tell us about large companies' earnings guidance? Unfortunately, the picture isn't encouraging.
As of Feb. 7, 2023, 39 S&P 500 companies issued negative earnings-per-share (EPS) outlooks for the first quarter of 2023. Only seven companies had positive EPS pre-announcements. This translates to a negative-to-positive (N/P) ratio of 5.6. By comparison, since 1997, the long-term N/P average is 2.5. And the N/P average over the previous four quarters was only 1.9.
Another scorecard
S&P 500 companies' earnings are declining. They're beating earnings estimates at a much lower rate than they have typically done in the past. Earnings guidance is more negative than it has been historically. We could also throw in several recession indicators that appear to be forecasting a U.S. recession. None of this seems to bode well for the prospects of the stock market continuing its current momentum.
Does that mean investors should stay away from stocks? No. It's still quite possible that the stock market could rise despite all of the negative signs. There's an old saying that stocks sometimes "climb a wall of worry."
However, long-term investors don't have to be concerned about how stocks perform over the short term. The S&P 500's track record is impressive over 10-year and 20-year periods. That's the scorecard that's arguably the most important of all.
