Earnings: Up or Down - what analyst expectations reveal about the market

Not only have earnings expectations been slashed, but the price investors are willing to pay for these lower earnings has also decreased this year, despite the fact that the P/E multiples are still above average. Remember that these declining earnings estimates raise the forward P/E ratio, making stocks become more expensive. A pricey S&P 500, with the Federal Reserve ("Fed") continuing to tighten financial conditions, may not sit well with investors especially after such a strong January. Indeed, Brian Wesbury (First Trust's Chief Economist) projected at the start of 2023 that the S&P 500 would grow by just 2%. It’s worth sense-checking this with the available data; at the end of February the S&P 500 sat at 3,982.24, the long-term average forward P/E was 17.9 and the EPS estimate was $221.8 (see above), which translated to 3,981.31. But analysts are still trimming their estimates.

Overall this drop in forward earnings estimates raises the S&P 500 Index’s P/E ratio and investors are questioning whether at 18.31, it is possibly overvalued (making it in-line with its 30-year average of 18.31). See our chart below.

^{Past earnings data is not a reliable indicator of future results.}




_{Source: Bloomberg. Data from 31/12/96 – 28/02/23. The S&P 500 Index is an unmanaged index of 500 companies used to measure large-cap U.S. stock market performance. For-ward P/E is the price of a stock divided by estimated forward earnings. Forward Earnings of S&P 500 is the next-twelve months consensus estimate.}

The good news?

While analysts are becoming more bearish on the overall market, certain segments or themes have remained resilient, with some even seeing their earnings estimates revised upward. This is despite the Fed's determination to rein in inflation by raising interest rates as well as wider growth concerns. Certain “growth segments” have borne the brunt of analysts’ aggressive earnings downgrades, where we’ve seen estimates cut for the information technology sector (by 9.5%) in the fourth quarter of 2022 and communications services sector (by 11.8%), a segment that contains heavyweights Google, Meta, Disney, and Netflix².

Here’s where a thematic approach may bring the market to life.

Investors might not be surprised to learn that those companies selling goods and services which are facilitating the world's transition to clean energy have seen their earnings estimates rise throughout 2022. With global governments devoting literally trillions of dollars to the transition to clean energy, policy has been supportive with this beginning to translate into current and near-term expected profits. Importantly, once the Fed shifted into its rate-hiking regime, profitability arguably became the single most important factor for investors.

Apples to apples

Below, we've highlighted the earnings growth at the beginning and end of 2022 for two key megatrends: digitalisation and the clean energy transition. This is the type of targeted investment that thematic investing may provide: zeroing in on areas of real growth in the market. 

Past earnings data is not a reliable indicator of future results.



_{Source: Factset. 31/12/2021 to 03/01/2023. The S&P 500 Index is an index of 500 companies used to measure large-cap U.S. stock market performance. Indices are unmanaged and investors cannot invest directly in an index. Past earnings data is not a reliable indicator of future results.}

Profitability and where to find it

But of course, growth only forms part of the equation. While investors may choose to focus on and be encouraged by these long-term growth expectations, this current market values profitability and fundamentals. The Nasdaq® OMX Clean Edge® Smart Grid Infrastructure Index (“QGRD”) currently showcases a portfolio with 97% profitability³. QGRD offers a compelling entry into the Clean Energy transition story; combining attractive valuations with almost twice the current sales growth and c.40% more long-term growth expectations than the S&P 500 Index, as highlighted below;



_{Source: Factset. As at 30 December 2022} 

Moving further into 2023 investors may want to consider a thematic ETF that offers more profitable companies with such a compelling valuation backdrop, as well as current earnings growth expectations that continue to defy the broader market.

_{(1 and 2) Factset, January 2023. (3) As measured by positive 2023 Earnings Estimates (as at 20 February 2023) (4) Includes Norwegian Cruise Line, Carnival Corporation and Royal Caribbean Group (5) Excludes Lucid & RivianReferences to specific companies should not be construed as a recommendation to buy or sell shares or other financial instruments issued by those companies, and neither should they be assumed profitable.}