Perspective :

Market Briefing: The Squiggles

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The relationship of earnings estimates to actual earnings

I love this chart. If there were a hall of fame of investment charts, this would be in it. Bravo Ed Yardeni!

A topic of infinite debate is that of earnings estimates. Today, that debate is focused on whether earnings estimates will hold up, or if inflation and rising interest rates are going to cause serious earnings damage. The parties involved; strategists and portfolio managers who appear near unanimously bearish on earnings, up against securities analysts who appear swimmingly optimistic.

Who is right? Are earnings just about to be crushed, or are businesses more resilient than almost anyone thinks?

Below is what I believe to be the best chart for this question. The chart depicts real earnings of the S&P 500® through time (pink line), and the paths of analysts’ consensus earnings estimates (blue squiggles) each year. What each “squiggle” shows is the path of consensus S&P 500 earnings estimates for the two years leading up to when earnings are actually known for that year.

The squiggles

Things to know:
  1. While actual S&P 500 earnings grow over time, earnings can quickly fall by 20 to 50%. This percentage is surprisingly similar to the declines stock prices experienced during those corresponding time periods.
  2. Almost every squiggle path is downward sloping. What that implies is that analysts are almost always overly optimistic about the future. That is, historically, the normal state of affairs for this relationship.
  3. If you squint your eyes on the 2022 squiggle, you will notice almost no degradation in earnings estimates. And we are almost at the endpoint, when the actual earnings will be known, implying that the analysts’ estimates are likely close to the actual earnings.
  4. Given inflation, rising interest rates, and falling asset prices one would expect that earnings are likely to be materially revised downward. However, the 2023 “squiggle” is still above 2022, implying expected earnings growth next year.
  5. Are analysts being overly optimistic, or are strategists and portfolio managers being overly pessimistic? I don’t know, I will tell you in a year. The truth is usually somewhere in the middle of great and terrible. However, the strategists and portfolio managers seem to be winning the debate, as the S&P 500 Index is already down almost 16% year-to-date (as of November 15, 2022) based on flat to positive earnings.

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