The Earnings Boom That Defies Convention

The S&P 500’s current earnings boom has left analysts and investors perplexed. In an era where market forecasts are often met with skepticism, the recent surge in forward earnings growth is remarkable.

Since 1990, forward earnings growth has only been stronger after two significant events: the global financial crisis and the pandemic. However, these periods were marked by massive plunges in EPS estimates, followed by a rebound in profits. The current boom, on the other hand, was preceded by a relatively modest 6% dip in forward earnings.

This subtle distinction highlights the unusual nature of this earnings cycle. Unlike previous booms, where companies could rely on a rebound from crushed forecasts, this time they must deliver profits that meet or exceed Wall Street’s already lofty expectations. As Kevin Gordon, head of macro research and strategy at Schwab Center for Financial Research, noted, “The market still got a reset, but it came through stock prices instead of collapsing profits.”

The boom is broad-based, with all 11 S&P 500 sectors reporting positive forward earnings growth. Eight of them are growing at double-digit rates. The technology sector is leading the charge, with an 82% growth rate powered by the chip industry’s enormous profit surge.

While megacaps like Apple and Amazon drive headlines, smaller companies are also experiencing significant earnings growth. In fact, the equal-weight S&P 500 index shows that the boom reaches well beyond just a handful of large-cap companies.

Investors should take note: this boom highlights the need for a more nuanced approach to investing. Relying solely on megacap stocks or sector leaders may no longer be sufficient in today’s market. Instead, investors must be willing to explore smaller-cap companies that are driving earnings growth.

The boom also has significant implications for the broader economy. As companies continue to deliver profits that meet or exceed expectations, it will likely fuel further stock price gains and potentially even drive inflationary pressures. This is particularly concerning given the already tight labor market and rising interest rates.

As we enter earnings season and Big Tech results begin to flow in, investors would do well to keep a close eye on these developments. With Wall Street’s forward earnings estimates now sitting at $373 per share – up 32% from last year – companies will need to deliver to justify these lofty expectations.

The current boom may defy convention, but it also presents a unique opportunity for investors who are willing to adapt and adjust their strategies accordingly. By taking a more nuanced approach and exploring smaller-cap companies that are driving earnings growth, investors can potentially reap the rewards of this remarkable market phenomenon.

The outcome will have far-reaching implications for the market and the broader economy. With the stakes higher than ever, it remains to be seen whether companies will be able to deliver on Wall Street’s expectations.