Half Full or Half Empty?

With 84% of S&P 500 Index companies having reported earnings, according to Factset, we now have a good idea about how second quarter earnings will come in. While 79% of those companies have beaten earnings estimates, it is important to know two things: 1) Those earnings estimates have been systematically reduced in the preceding months, which means that these earnings have exceeded a lowered bar and 2) Even though expectations have been beaten, earnings are on track to decline about 5% from a year ago.

So, how do we view this dualistic earnings dynamic? On the negative side, earnings are down. On the positive side, earnings are coming in better than expected! The market seems to be pricing a recovery in earnings that suggests the worst of the earnings decline is now behind us, and that earnings will be up from here. Below is a look at the market’s return path on its way to being up about 10% over the last year even as earnings have come down 5%. This leaves us with a forward PE ratio of about 20%, which frankly is a little rich.



Looking into the future, consensus S&P 500 Index forward earnings expectations one year from now are $233 according to Dr. Edward Yardini (www.yardini.com). The 4500 S&P 500 Index price today makes it very hard to feel good about buying 12-month forward earnings at nearly a 20 multiple. Are we indeed entering a period of reaccelerating earnings growth as the market seems to be pricing, or have we gotten a little ahead of ourselves with more earnings challenges in front of us? Or, put another way, is the glass half empty while being drained, or half full while being replenished? That’s the focus of almost all market participants for the remainder of the year. It seems like it could go either way. For long term-oriented investors, it is less important as S&P earnings of $400 in 2030 seems like a highly likely outcome. Put 20 times on those future earnings and we are talking about S&P 8,000. Our guess is that most investors could live with that!



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