S&P 500 Earnings Have Been Great. Why It Isn’t Good Enough for the Stock Market.

The solid earnings results reflect the third quarter’s far better-than-expected economic growth. The fact that the aggregate earnings “beat” has outpaced that of sales illustrates that profit margins are also better than anticipated—especially as the increases in product costs and employee pay are moderating. All sectors thus far have beaten bottom-line estimates.

But despite the strength in corporate earnings, the
S&P 500
has fallen about 3% from a month ago, just as earnings season was about to begin. In fact, the index is down about 10% from its 2023 peak hit in late July. The S&P 500 has dropped 0.5% on Friday.

The problem is simple: Stocks were just too expensive coming into earnings season, and, on top of that, most companies have refrained from lifting their profit forecasts.

Even companies that are beating earnings estimates aren’t seeing their stocks get rewarded much. For the past five years, companies that have beaten analyst estimates for both earnings and revenue have seen their stocks climb an average 1% on the trading day after the earnings report. But for the 2023 third quarter, firms beating both top- and bottom -line estimates have seen their stocks gain an average of just 0.5% on the trading day after earnings, according to Evercore. Mix in the stock performance of companies that missed profit estimates, and the average stock price reaction on earnings release day for all earnings reports this season has been a 1% decline.

That’s partly because stocks were expensive already. The S&P 500 has rallied for most of this year: It came into this earnings season trading at about 18 times analyst’s per-share earnings estimates for the coming 12 months, up from just under 17 times at the start of the year. Many on Wall Street agree that the index’s current valuation multiple is high, particularly as higher interest rates make future profits less valuable and should eventually weigh on multiples. Stocks’ already-rich valuation means that earnings results have to surpass expectations by leaps and bounds—not just by a little bit—to justify high share prices.

Making the issue worse, companies haven’t lifted their profit forecasts for the fourth quarter. Since Oct. 3, not one S&P 500 company has raised its fourth-quarter EPS guidance in their comments on the earnings releases. One company, chemical maker
FMCCorp.
(FMC), lowered fourth-quarter profit guidance in an earnings pre-announcement. FMC said customers around the globe are destocking, or limiting their purchases of new products to reflect their own expectations of subdued demand going forward.

Such poor guidance isn’t necessarily a surprise. While the economy has been strong in the past few months, higher interest rates usually take full effect on the economy with a delay, so growth should slow from here. Some companies are already seeing evidence of that, and the stock market is looking straight past third-quarter results to prepare for that reality.

Write to Jacob Sonenshine at [email protected]