What earnings revisions can reveal about upcoming market trends

02/28/2024 — As the end of Q4 earnings season approaches, three-quarters of S&P 500® Index companies have reported actual earnings above estimates, according to FactSet, around the 10-year average of 74%. Although this news is encouraging, these statistics raise a critical question for investors: Is it relevant to focus on past earnings beats, or is future earnings-per-share guidance more pertinent?

Focusing on earnings revisions is more informative for investors, as they capture evolving trends that investors who are solely fixed on a narrow set of economic indicators (e.g., Leading Economic Index or inverted yield curves) may miss. Additionally, looking at the stock market’s forward-looking nature reveals the power of earnings revisions in illuminating subtle yet impactful trends lurking beneath the surface of the stock market and the broader economy. In a sense, earnings revisions may be a better barometer of forthcoming shifts or trends.

It took over two years for the S&P 500 to reach a new all-time high after peaking in January 2022. For those who remember the October 2022 bear market low, investor sentiment was dour, and many economists predicted an imminent recession.

Traditional indicators of an economic slowdown only fanned investors’ bearish fears. However, as seen in the accompanying chart, net revision momentum slowly began to support the S&P 500 during the fourth quarter of 2022. This momentum likely started from the market’s ability to transcend short-term bearish sentiment, driven by the likely convergence of two potent market trends to generate a decent tailwind for the S&P 500.

The first trend consisted of improving forward-earnings growth, escalating capital expenditure investment, and resilient corporate margins. Likewise, the second trend consisted of receding inflation, the indications of future Federal Reserve rate cuts, and improving productivity in the economy. As such, the market’s surprising rise to all-time highs and, more importantly, the gradual increase in earnings revisions have endorsed these trends. Although pullbacks may be expected in any given year, the fundamental backdrop doesn’t support the likelihood of a severe bear market, such as the one we saw in 2022.