- US S&P 500 index is powering higher, but earnings estimates are leaking lower
- At least reduced expectations increase the chance of earnings ‘beats’
- Softening American economic data may be a new challenge
“The second-quarter results season is upon us and investors will be looking for upbeat commentary, positive earnings surprises and optimistic outlooks for the second half of the year to help the headline American stock market indices set new all-time highs,” says AJ Bell investment director Russ Mould. “Such good news may be needed, however. Consensus earnings estimates for the S&P 500 in Q2 2024, and this year overall, are 2% lower than a year ago, even if the index is up by 25% over that period, and such an upward re-rating cannot go on forever.
Source: Standard & Poor’s Research, analysts’ consensus estimates
“The result of the index forging strong gains even as earnings estimates have dribbled lower is a forward earnings multiple of 23 times for 2024. According to FactSet, this compares a five-year average of 17.2 times and a ten-year average of 15.5 times. So, in theory, either earnings estimates get a wiggle on or the S&P 500 could start to run out of puff, burdened by the weight of expectations in the form of a premium valuation.
Source: Standard & Poor’s Research, analysts’ consensus estimates
“And, ultimately, the price paid to access the earnings or cash flow of an individual security or an asset class is the key arbiter of investment return – the higher the price, or valuation, paid, the lower long-term returns are likely to be, as Professor Robert Shiller’s long-term study of the S&P 500 in the context of his cyclically adjusted price earnings (CAPE) ratio makes only too clear.
Source: Shiller Data
“The good news so far is that the US economy continues to defy an inverted yield curve and keep growing, to provide valuable support to those earnings forecasts. However, the Atlanta Federal Reserve’s GDPNow GDP growth forecast for the second quarter of 2024 has slipped sharply lower to an annualised rate of 1.5%, compared to early estimates of 4%.
Source: FRED - US Federal Reserve database, Atlanta Fed GDPNow estimates for Q2 2024E
“Although the S&P 500’s members are global multi-nationals, any marked slowdown in domestic activity could have a negative impact all the same, even if analysts remain hopeful that AI and all its knock-on effects can support and drive corporate profits.
“A weak order intake figure from last week’s Institute for Supply Management (ISM) purchasing manager’s index (PMI) does not bode too well for the second half, especially as the manufacturing order intake survey score continues to languish below the 50 mark, a reading that is usually taken to signify a slowdown, if not outright economic contraction.
Source: US Institute for Supply Management, LSEG Datastream data
“The US economy has defied similarly weak readings from manufacturing industries for almost two years, so even that does not make for an open-and-shut case, but it does seem likely rampant Federal spending is compensating for, and covering up, a multitude of sins.
“The Congressional Budget Office raised its estimate for the annual deficit for the year to September 2024 to $1.9 trillion from $1.6 trillion and further spending could help to provide some support – although a chunk of that increase was the result of higher interest expenses on America’s galloping Federal debt, which will offer a much lower multiplier effect than, say, productive expenditure on infrastructure or the Inflation Reduction Act and the Chips Act.
Source: LSEG Datastream data, FRED - US Federal Reserve database, Congressional Budget Office
“Admittedly, neither President Biden (should he get a chance to run and be re-elected) nor Donald Trump seems likely to ease off on spending or, in the latter’s case, tax cuts, but that does not mean bond market vigilantes will necessarily take such fiscal largesse in their stride, and the danger of convulsions in the US Treasury market is something that equity investors may need to consider when they look at how much support the US economy can provide to American corporate earnings going forward.
“Intriguingly, global purchasing manufacturing indices look more encouraging than their US equivalent. If the rest of the world does show better momentum than America, that would represent a major shift compared to the past few years and again could be a reason for stock market investors to consider whether US equities really should trade at such a massive premium to stock markets in Europe and the UK, which trade on nearer to 13 times and 11 times forward earnings, even allowing for different sector mixes and exposures.”
Source: S&P Global, LSEG Datastream
