Analysts have returned to the mode of increasing their earnings forecasts, a change that has boosted the stock market and may make investors more confident about the outlook.
In recent weeks, more forecasts have been increased than they have been reduced, according to data from RBC Capital Markets. At the end of October, the upward revisions accounted for 54% of all changes to date in analysts’ forecasts for 2021 or 2022 profits for companies in the
according to the bank. That’s up from 51% in the middle of the month.
It isn’t clear what makes analysts more optimistic, but this change could be a sign that supply chain issues that have limited what companies can produce or sell may decrease. Product cost increases may moderate. Recently, the cost of shipping goods has fallen, while profit margins have exceeded estimates.
Stocks rallied widely, a key point as earnings of companies in various industries are affected by changes in the supply chain. The
Equal Weight Invesco S&P 500
Exchange-traded funds (ticker: RSP), which reflect general market movements rather than being influenced by the gains or losses of a few large players, rose 5.5% over the past month.
Companies with better-than-expected third-quarter profits saw their shares gain 0.63% on average the day after the results were released, according to RBC. “Consensus EPS for 2021… continues to point to a fairly strong earnings season overall and also helps explain why the stock market has continued to rise during reporting season,” wrote Lori Calvasina, strategist in Head of US Equities at RBC.
There is just one caveat. Historically, the stock market has performed poorly a year after increases in earnings expectations peaked.
This is important because in August the share of all changes in earnings forecasts that were higher peaked at 78%. two standard deviations above the historical trend. When analysts frequently raise estimates over history, the S&P 500 averages a 4.9% gain over the next 12 months. The the average annual gain, from January to December, is well above this level.
In February 2018, when the upward revisions also peaked at 78%, investors might have been well advised to sell. The market sold off at the end of the year as the Federal Reserve continued to raise interest rates to dampen economic growth and avoid inflation.
A major risk right now is that rising inflation will force the Fed to raise rates just as economic growth is slowing. But that’s not a concern for 2021. For now, higher earnings forecasts can only do the stock market good.
Write to Jacob Sonenshine at [email protected]