Virtually every strategist who has made a bullish prediction for the
this month has talked up corporate profits.
While companies certainly have done well this earnings season, there’s a disconnect between those results and stock market gains. The S&P 500 has raced far too ahead of earnings expectations for this year, according to Rosenberg Research’s David Rosenberg.
Wall Street estimates that S&P 500 companies’ aggregate first-quarter earnings will grow 7.1% versus a year ago, outpacing the 6.7% growth predicted at the start of the year, FactSet data show. Estimates have climbed as investors have seen nearly eight out of every 10 companies beat consensus earnings forecasts—with very few firms left to report this season.
It’s common for corporate profits to surpass estimates, as analysts typically make conservative guesses. But this quarter has been unusually good: The percentage of companies reporting higher-than-expected earnings has exceeded even the long-term average rate of 74%, FactSet data through Friday shows.
That isn’t the only notable statistic. Typically, when a company’s quarterly financial results outperform, analysts’ earnings estimates for subsequent quarters decrease to align with full-year projections. But S&P 500 aggregate earnings estimates have remained robust for the 2024 second quarter, sticking around $59 per share since the start of the year—even amid such a strong first quarter.
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So it would seem logical for strategists to raise their S&P 500 targets to account for further market gains. A number of Wall Street analysts, including from UBS, BMO Capital, and Morgan Stanley, have upped their forecast for S&P 500 returns this month, citing earnings.
The median target price among analysts polled by FactSet is 5,894.14. That implies a further 12% gain this year from Wednesday’s close at 5,266.95, compared with an expectation of a 10% rise in April.
But there’s a reason to consider the contrarian strategy, especially when the markets are this exuberant. (The S&P 500 has climbed 10% this year, hitting a record high more than 20 times.)
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Investors are now paying 21 times for each dollar of the S&P 500’s projected profits over the next year, compared with 17 times during October’s market low. The multiple surpasses historical averages going back 25 years.
Investors’ willingness to buy in on the expensive valuation signals an expectation of even bigger gains in the future—even though the S&P 500 has already climbed 28% since an October low point.
And that’s where the disconnect lies. Profit growth for the first quarter has only been about one-fourth of the market’s monstrous gain since October, while 2024 earnings estimates have seen minimal change.
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“This Is NOT an earnings-driven stock market,” Rosenberg said Wednesday. “It has actually been four parts multiple expansion and one part EPS growth.”
That’s to say, a big chunk of the market’s climb is coming from rosy expectations or higher valuations, rather than fundamentals. In fact, the jump in the market’s price-to-earnings ratio since October is rare; it has only happened 5% of the time over the past three decades, Rosenberg added.
The market’s extreme bullishness has been well-documented. The two well-known indicators to gauge market sentiment—Investors Intelligence and American Association of Individual Investors surveys—are showing that there are more bulls in the market than bears.
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Now, the questions are how long the bullishness can continue, when many optimists have already poured in plenty of cash, and what could trigger a market pullback. Strategists have been looking for a dislocation in the Treasury market, closely monitoring each government auction for poor sales. A big ugly auction—like the one in November—would likely punish equities; that would signal that there’s too much debt and investors are demanding higher interest rates. Stocks often fall when Treasury yields rise, as that makes bonds more attractive relative to equities.
Other potential headwinds are if demand in artificial intelligence wanes—or if regulation threatens that market—as AI-related stocks have been a driving force behind the market rally. U.S. equities could also come under pressure if there is an escalation in geopolitical tensions or if China fails to stabilize its economy.
Even without a major event that triggers a selloff, the market’s steep price tag might be enough to make the high-fives on Wall Street a bit concerning.
Write to Karishma Vanjani at karishma.vanjani@dowjones.com.
