S&P 500 poised for strong first-quarter earnings; will it be enough?


Source: S&P Dow Jones

Authored by RSM US LLP

Last week marked the unofficial start of earnings season with major banks such as JP Morgan, Bank of America, and Wells Fargo reporting. In aggregate, S&P 500 corporations are poised for their largest year-over-year increase in quarterly earnings in a decade. While that’s certainly good news, the Index is already up a remarkable 53.7% since the end of the first quarter in 2020; its best four-quarter gain since World War II. So what are we watching out for that may indicate the market has gotten ahead of itself?

The run-up in the Index’s price-to-earnings (P/E) over the past year has been driven by a rising numerator, while the denominator fell dramatically. A return to near-zero, short-term interest rates following the onset of the pandemic provides some measure of justification (using a lower interest rate to discount future cash flows results in a higher present value). But normalizing the P/E shows that it’s now at its highest level in the last 20 years; surpassing both the Financial Crisis and Tech Bubble. Consequently, we expect aggregate earnings will need to come in notably higher than the roughly 25% year-over-year growth FactSet is currently estimating in order for further price gains.

While it may seem unlikely that index-level earnings will top the already-high bar, it’s worth noting that quarterly earnings have exceeded consensus estimates by an average of 6.9% over the past three years. And over the past three quarters, earnings have handily beaten expectations by an average of 19.0%. So while we expect a reversion to the mean in the P/E, as long as companies reported earnings continue to top estimates — which we view as likely — we expect the index to continue moving higher; though investors may want to temper expectations.

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