- I’ll first describe what’s going on with earnings as 55% of companies have reported. We’ll discuss insurance a bit more.
- A helicopter view shows that the S&P 500 averages have a large distribution.
- I’ll conclude with some inconsistencies everyone should be aware of when listening to Wall Street and earnings.
55% of S&P 500 companies have now reported earnings, and it’s always nice to check those aggregate earnings to see how the market is breathing.
I‘ll show you the data from the current earnings, which are very interesting, but I’ll also show you the difference between what Wall Street is painting and reality. Let’s start with current earnings.
S&P 500 Earnings
The earnings growth rate for Q3 2017 is 4.7% which is much better than the growth rate of 3% estimated on September 30, 2017. Therefore, 76% of the companies that have released so far have reported positive earnings surprises.
The largest detractor to earnings growth isn’t coming from the energy sector as has been the case in the past few years, but rather from insurance. As we know, insurance earnings are usually volatile and the recent natural catastrophes certainly haven’t helped.
The funny thing is that insurers reported and are expected to report losses due to the hurricanes, but this hasn’t abated their rally. Insurers saw a dip the moment the hurricanes hit the coast, but quickly recovered.
Even though Chubb (NYSE: CB) reported a quarterly loss, the stock price soared as the results were above estimates and many investors expect insurers to be able to raise their premiums after the hurricanes. It’s interesting how the world works; someone’s loss is someone else’s gain.
This is also a good opportunity to look at how insurers have performed since the financial crisis. CB’s long-term trend only shows stability and constant growth, this is very strange for a highly competitive, low margin, low growth, prone to catastrophes business like insurance. This means that either investors overreacted to the 2009 crisis and avoided insurers for no reason in the post crisis era, or we are looking at a new bubble. Nevertheless, deep market knowledge is needed for estimating such investments.
Back to current earnings, the growth is 4.7% but the energy sector has seen earnings grow 130% which is logical thanks to higher oil prices. Industrials, utilities, telecoms, financials thanks to insurers, and consumer discretionary, have all seen earnings decline. IT, real estate, and healthcare are simply continuing on their growth path.
What’s even more important than current earnings are future expected earnings and they are spectacular. Wall Street analysts estimate 2018 S&P 500 earnings growth at 11.4%.
The estimations are consequently used in Wall Street’s favorite valuation metric, forward earnings. The only logical explanation I’ve found in using forward instead of past earnings is that forward earnings are usually higher, which thus lead to lower valuations making stocks look cheaper and easier to sell. Nevertheless, the forward price to earnings ratio is also significantly above historical averages.
Now, you should be very careful when using estimated forward earnings for making investment decisions. If I go back just to February, earnings estimations were far more positive than the actual results were. Earnings growth of 4.7% is extremely good, but far from the 11.1% growth expected at the beginning of this year.
The issue with analysts is that it’s their job to be optimistic and positive as they work for Wall Street which makes much more money when asset prices grow and people are positive.
Consequently, only 5% of analysts’ recommendations are sell recommendations, which doesn’t make sense as 50% of stocks will underperform while 50% of stocks will outperform the market, thus the buy sell recommendations should be much more level.
We’d get a fair picture if we equalized a hold with a sell. Perhaps that’s what analysts think but aren’t allowed to say due to the imposed positivity on Wall Street.
Unsurprisingly, most analysts buy recommendations are in the hottest sector, IT, while hold—or maybe it’s better to say sell—recommendations are in the worst performing sectors like Telecom and utilities.
Remember that the forward estimates don’t include any kind of future shock because that is impossible to predict. Even financials were expected to grow earnings at 10% in 2017 back in February, but then a shock happened. This is very important because it also shows where Wall Street’s focus is, i.e. on the last few quarters where the past is replicated into the future.
Shrewd investors who dare to look just a bit beyond where Wall Street looks can reap extraordinary gains. The only thing to do is to estimate what Wall Street will estimate, thus what will happen in 6 to 12 months, not in the next 6 months.