The day the stock market music died
Then came April 26. On this date, the forecasts for stock market earnings reached their peak. And in the months since, these forecasts have rolled back over at an accelerating rate.
Consider the following. On April 26, the following were the projected 12-month earnings per share on a GAAP basis according to S&P Global:
2018 Q1 $117.79
2018 Q2 $128.56
2018 Q3 $139.63
2018 Q4 $154.23
2019 Q1 $158.24
And here is where these same readings are as of the most recent reading on August 10.
2018 Q1 $115.44 (final reading), lower by -2.00%
2018 Q2 $122.65 (>90% of companies reported), lower by -4.60%
2018 Q3 $131.26, lower by -6.00%
2018 Q4 $143.66, lower by -6.85%
2019 Q1 $148.51, lower by -6.15%
Don't get me wrong
The forecasts are still calling for phenomenal annual earnings growth in the +20% to +30% range on a year-over-year basis in the coming quarters. It's just that these forecasts were in the +30% to +40% range a few months ago. Thus, it is more a story about a deceleration in growth at this stage. But it should also be noted that earnings results for the third quarter, the fourth quarter and the first quarter of next year are still many months away at this point. In the meantime, these forecasts are dropping like a rock.
Why does this matter?
Because today's stock market is expensive with a capital EXPENSIVE. It is the second most expensive stock market in history next to the tech bubble. And if you want to know what decelerating earnings growth can look like - even if it is still robust growth - when it is associated with really expensive assets, take a look at the price chart for Facebook stock over the past month.
Not saying the S&P 500 Index is going to drop -24% in a day October 1987 style by any remote stretch of the imagination, but you get the idea. Expensively priced assets are more prone to more pronounced price declines the more expensive they become, even if underlying fundamentals are not only sound but strong.
Let's get back to earnings
It is worthwhile to dig a little deeper into decelerating earnings forecasts. First, let's focus on the quarterly readings. The following were the quarterly forecasted GAAP earnings for the S&P 500 Index on April 26.
2018 Q1 $35.37
2018 Q2 $37.78
2018 Q3 $39.52
2018 Q4 $41.56
2019 Q1 $39.38
And here are these same readings as of August 10.
2018 Q1 $33.02 (final reading), lower by -6.64%
2018 Q2 $34.22 (>90% of companies reported), lower by -9.42%
2018 Q3 $37.06, lower by -6.22%
2018 Q4 $39.36, lower by -5.30%
2019 Q1 $37.87, lower by -3.85%
Returns brought forward, earnings pushed back
Let's break this down. Roughly four months ago, we were forecasted to get earnings of $37.78 per share on the S&P 500 Index in the quarterly numbers that we are getting from companies right now in Q2 earnings season. Instead, we ended up getting about one-tenth less than forecast. As for that 2018 Q2 earnings number forecasted back in April, that's been pushed all the way back to 2019 Q1. And that assumes that no more downward revisions take place between now and April 2019 when the numbers for that earnings season start to finally come out. This, of course, is a tough leap given that a hatchet is repeatedly being taken to quarterly S&P 500 earnings growth forecasts each week as of late.
Stock market squeeze box
All of this has created the following condition for the U.S. stock market. While the S&P 500 Index has risen by +8% since late April, the projected earnings upon which stocks are being priced have fallen by -5% over the same time period. This is not helping the extreme valuation problem the stock market continues to face despite all of the robust earnings growth that is already in the bank so far.
Still dancing while the music stops
The bigger issue for the stock market is what lies ahead. Despite all of the hoopla coming into 2018 about how great things were going to be around the world, it has been anything but. The U.S. economy did well in 2018 Q2, but signs are increasingly suggesting that this may be the growth peak and that gains are set to decelerate from here. And the economic situation around the rest of the world is becoming increasingly messy, particularly across a broadening swath of emerging markets. The one very big thing that the U.S. stock market had going for it was the forecasted phenomenal earnings growth to come thanks to the landmark corporate tax cuts. But if it turns out that this expected earnings growth was nothing more than a sugar high induced mirage, this is all the more problematic for the U.S. stock market outlook, particularly since strong earnings growth is already priced into the market and then some.
Get down, get down
The U.S. stock market continues to rise, and new all-time highs on the S&P 500 Index appear all but certain before the month of August draws to a close. But know the fundamentals underlying the stock market in which you are investing. Keep a close eye on corporate earnings growth forecasts as the bull rages on, as they are sounding an increasingly disharmonious tune with each passing week. And this may start to prove particularly problematic for stocks once the current record stock buyback activity starts to recede.