Noise

   By Guest Blogger Ryan Lewenza

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So, I guess the US economy isn’t heading for a recession after all and our portfolios are not all doomed? That was the narrative from the financial media when the markets took a swoon a few weeks ago. In my last blog I took the financial press to task over their often incomplete and hyperbolic reporting around normal market corrections. Since then, the markets have rebounded strongly, with US stocks having their biggest weekly gain of the year last week.

As we often stress in these blogs, we try to block out the market noise and focus on what’s actually important and what drives stock prices. Examples of market noise are one disappointing economic print, a poor government bond auction, or some ‘financial expert’ making bold predictions of an imminent market crash.

Harry Dent comes to mind on that last point. Please do me a personal favour and throw any of his books you own in the trash heap and immediately delete any emails where he yet again claims a market crash worse than the Great Depression is just around the corner. Him and his ilk are the worst!

Investors should instead focus on the main factors that actually drive stock prices. This includes things like economic activity/growth, the business cycle, central banks and their interest rate policies, and most importantly, corporate earnings.

Why are earnings so important? Well, over the long run there is a 96% correlation between the S&P 500 and their underlying earnings. Essentially where earnings go so do stock prices. This is why some say ‘earnings are the mother’s milk of stock prices’.

S&P 500 and trailing earnings

Source: Bloomberg, Turner Investments

Given the importance of corporate earnings, let’s check in to see how they are shaping up in the last reported quarter and what we should expect for the full year.

We’re just about done with this second quarter earnings season with 93% of companies in the S&P 500 reporting results and overall it was a very solid quarter.

First, 79% of companies in the S&P 500 beat analysts’ estimates, which is higher than the typical 74% that beat results over the last 10 years. According to Factset, in aggregate, companies are reporting earnings that are 3.5% above analysts’ estimates.

Second, and most importantly, profits look strong with S&P 500 earnings on pace to jump 10.9% from a year ago, better than what analysts expected at the end of June. This marks the largest quarterly increase in over two years and is the fourth consecutive quarter of positive yoy earnings growth. So, we’re seeing strong earnings growth from the big US companies, which, given the high historical correlation with stock prices, is clearly a big positive for the equity markets.

Isn’t it interesting that you don’t hear much about this positive development from the financial press? Nary a sound from the press on these robust quarterly earnings since this doesn’t sell newspapers or garner clicks.

When we look at the full-year 2024 expectations for US corporate profits, the outlook looks much the same. For the full year S&P 500 earnings are projected to be up 11% from last year, which is well above the long-term historical average of 7% earnings growth.

This is a key reason why Garth, Doug and I remain bullish on stock prices over the next 12-18 months.

Now it’s not all roses. There are some concerns that keep us up a night and could portend further market volatility over the next few months.

First, US equity market valuations are elevated. When the S&P 500 was at its peak of 5,600 in mid-July, the P/E got up to 22x, which is quite high. Following the recent correction the P/E has come down to 21x, but this is still above the 5-year average of 19x.

Second, as we’ve noted in recent blogs, the US equity markets often dip ahead of US elections in early November. I crunched the numbers and on average the S&P 500 declines 6% from August to the end of October, just ahead of US elections.

Finally, we’re fast approaching the weakest seasonal period for the equity markets. As seen in the chart below, September is historically the weakest month of the year for the US markets. October has also experienced some big down months, so history suggests an increase in market volatility as we head into the fall.

But with the US economy still doing well, the Federal Reserve soon to start cutting interest rates, and corporate earnings rising, this more than offsets the higher valuations and weaker seasonal period, and why we believe stocks have more room to run in the months ahead.

So, block out the noise and focus on the key fundamentals like corporate earnings, which look set to keep rising.

S&P 500 average monthly performance

Source: Bloomberg, Turner Investments

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Investment Advisor, Private Client Group, of Raymond James Ltd.

Source: https://www.greaterfool.ca/2024/08/24/noise-2/