Equity View: 2024 Earnings Priced for Perfection?

Summary 

• Equities have been mired in a tight range since early summer as markets weigh the pressures of rising rates against ongoing evidence of a robust economy. 
• Current projections for 2024 should support equities – earnings are expected to be up 11% for the S&P 500 and 33% for the NASDAQ 100. 

• These forecasts do not reflect the growing sentiment that the Fed could be headed towards a higher-for-longer rate regime. 

Market Implications 

• Equity investors pay close attention to earnings forecasts. If current projections are revised downward later this year or early next year, equities will remain in a trading range or fall to reflect an evolving reality. 

How Reliable Are Earnings Forecasts? 

After the ups and downs of the past two years, equities have been mired in a narrow trading range for the past three months. Headwinds have been increasing: rising rates and stubborn inflation that is stopping the Fed from easing as many investors had hoped. Yet on the plus side unemployment remains low, and the economy is still in growth mode. 

But another – perhaps key – factor has been a combination of flatlined earnings over the past 15 months (with earnings for the S&P 500 (SPX) wrapped around $220 per share on a trailing and full-year forecast basis) and a forecast of an 11% gain in 2024. Equities track earnings growth closely, with fluctuations depending largely on what investors are willing to pay for those earnings – i.e., P/E valuations (Chart 1). 

Equities may be on hold now given near-term earnings prospects but rising earnings in 2024 should be bullish for SPX and equities in coming months (FY2 in Chart 1). 

For background, analysts update their earnings forecasts for the one and two (and more) years ahead early each calendar year. Trailing earnings then typically ‘catch up’ to forecasts, and/or forecasts are revised upon new information.  

It Is About the Trend 

The issue is that analysts usually project the current trend will continue. In Chart 2, we line up trailing earnings with what analysts were projecting one and two years ago. When the economy and earnings are in trending growth mode, such as between 2011 and 2018, earnings projections are very good.  

But analysts are very bad at anticipating recessions. Shortly before the recession and earnings decline in 2008, analysts projected the recent trend would continue for the next two years.  

They also missed the 2018 earnings surge and had to play catch-up. And, of course, no one could have foreseen the Covid pandemic and the abrupt shifts in consumption, work practices and supply chains since 2020. No wonder earnings projections have been decidedly out of synch with reality. 

Covid Scrambles the Outlook 

Examining the past few years, earnings projections in early 2021 proved to be initially low, then kept getting revised higher and ended the year on target (Chart 3). 2021 earnings were expected to rise about 30%; they ultimately rose 47%. In 2022, analysts projected another bumper crop of earnings, with both 2022 and 2023 earnings rising about 10%.  

Instead, inflation accelerated, and the economy ran into the buzzsaw of rising rates. Both one-year and two-year earnings needed downward revision. 

In early 2023, analysts correctly forecast flat earnings for the 2023 – but pencilled in a 9.3% gain for 2024 earning.  

That is the basis for optimism about 2024 earnings – a forecast from early 2023. The good news is that projection has remained stable, so far. The bad news is we are only halfway through the year in earnings terms. There is still plenty of time to revise it based on the year-to-date experience. The 2024 outlook could differ considerably by yearend and again after revision in early 2024. 

Earnings Surge Coming for NASDAQ 100? 

Earnings for the NASDAQ 100 (NDX) show a similar pattern for 2021 and 2022 – upward revisions to forecasts throughout 2021, then large downward revisions in 2022 (Chart 4). 

SPX and NDX part ways in 2023. Analysts continue to expect 2023 earnings to end the year about 10% above the present $500 over the past year. That requires sharply higher 2H2023 earnings. And 2024 earnings keep getting revised higher – from a 25% gain projected in January to a 33% jump currently.  

Such is the optimism about a coming artificial intelligence boom.  

Caveat Emptor… 

Earnings forecasts matter. In our modelling of drivers of equity prices, forecast earnings have far more explanatory power than trailing earnings. 

So, we are not here to say these 2024 forecasts are wrong or should be discounted. We can say that as they are either confirmed or (more likely) revised in coming months or early next year, it could be market moving, especially for the tech sector. 

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)