The Profits Stocks Prophesized

With S&P 500 earnings season nearing completion, we can now draw some conclusions and interpretations of the results. And, to us, the major takeaway from these backward-looking figures is simple: They confirm this bull market isn’t built on sand and hot air.

With 427 companies having reported as we write, the blended earnings growth rate is 5.5% y/y.^[i] This figure, for those who don’t have their financial jargon glossary handy, blends actual results for the 427 reporting firms with estimates for the remaining dozens. So while the stragglers could pull the headline rate down some, it seems safe enough to say earnings grew for the third straight quarter.

Growth was broad-based, too, with 8 of 11 sectors growing and only Materials, Energy and Health Care in the red. Communication Services led the charge at 35.8% y/y, driven by whopping 70.2% growth in its Interactive Media and Services industry.^[ii] Pair this with Tech’s 22.7% y/y and Consumer Discretionary’s 24.0%—led by e-commerce—and it seems clear to us the Tech and Tech-like firms leading the charge during this bull market are doing so for concrete reasons, not just AI hype and other associated faddish chatter.^[iii] Yet the more value-oriented Industrials (6.7% y/y) and Financials (7.2%) also did well, underscoring the bull market’s underappreciated breadth.^[iv]

Encouragingly, growth came not just from cost-cuts, but from higher activity overall. S&P 500 revenues rose 4.2% y/y, with Communication Services leading the charge here, too.^[v] Eight sectors also saw revenue growth—including Health Care—while Utilities joined Materials and Energy in the red. This isn’t much of a surprise, considering natural gas prices are down this year, which drags on electricity rates. It is also probably immaterial to the bull market, given Utilities is a defensive sector and tends to shine brightest when markets are pricing in economic trouble—then, Utilities’ relatively stable revenues are far more attractive than they are when everyone else is growing.

Earnings are one of those things people think should drive stocks as they are announced. We see this all the time, with focus on how companies perform in the wake of their earnings releases. And there is a short-term impact, naturally. In its latest Earnings Insight publication, FactSet also hopped on this train, noting that the market seems to be rewarding positive earnings surprises less than usual. To us, this is a function of myopia. It misses the point about how markets work and what Q1 earnings’ real impact is.

Markets are forward-looking, while earnings results look back in time. Stocks tend to pre-price expected events within the next 3 – 30 months. So they have already anticipated, lived through and priced whatever happened in Q1 2024—and Q1 2023, when the year-over-year comparison was set—to lead to these results. The results themselves just confirm what stocks already knew intuitively.

So in our view, a better way to see earnings’ market impact is to look at how stocks behaved over the last 12 – 18 months or so as they priced this eventual reality in. Here, we see the thread crystal clear. The bear market in 2022, while predicated primarily on sour sentiment toward inflation, rate hikes, the war in Ukraine, energy prices and a host of other interrelated angsts, nonetheless presaged (and pre-priced) a corporate earnings downturn.

The earnings downdraft started in Q4 2022, nearly a year after the S&P 500 peaked early that January. Earnings kept declining through Q2 2023, with growth returning that Q3. But stocks didn’t wait for the earnings recovery to show in the data. The new bull market started in October 2022 as stocks looked ahead to earnings growth’s eventual resumption.

No, markets didn’t pinpoint the timing in advance. That isn’t how this works. But simply seeing the extent of the top- and bottom-line impact from higher costs and prices was enough to give markets confidence that a recovery would come sooner rather than later, beating the dismal expectations that reigned at the time. That was enough.

Since then, the S&P 500 has enjoyed a very nice run, albeit one punctuated by a correction (sharp, sentiment-fueled drop of -10% to -20%) last summer and early fall. The young bull market is far from history’s strongest—actually, it ranks toward the bottom of the leaderboard in returns over the first 18 months. (Exhibit 1)

Exhibit 1: Bull Market Returns in the First 18 Months

Source: Global Financial Data, Inc., as of 4/15/2024. S&P 500 price returns in the first 18 months off bear market lows. Price returns used due to daily data availability.

But a bull market it is, lifting the S&P 500 to new highs as stocks anticipated an earnings recovery gathering momentum. You could say this bull market, to date, is stocks’ reaction to the string of three positive quarterly earnings reports Q1 extended (and will likely persist, in our view).

Keep this in mind as it pertains to Energy now. The sector rallied late in Q1 as oil prices rose, leading it to outperform at the last minute. That might seem odd now that we know Energy sector earnings fell -25.6% y/y in Q1.^[vi] But here, too, we think stocks were looking forward, to the high likelihood that oil prices hover near the upper end of their 2023 range this year. That would be a longer-term plus for earnings in the sector, which hinge on prices rather than production volumes. Consensus expectations are already starting to reflect this, penciling in 18.5% y/y projected earnings growth for Energy in Q2.^[vii] There should be plenty more where this came from, what with US production growth slowing as rig count wanes and global demand proving stronger than expected. Markets just moved first, as usual.

So no, Q1 earnings don’t tell us what stocks will do. Rather, we think they shed additional light on why stocks did what they already did. They are context. Backward-looking evidence. And very nice! We like earnings! But they are confirmers, not predictors.