Earnings are topping expectations, like usual … the narrowest equity risk premium in 20 years … exactly where the market is in the AI growth cycle … the latest jobs numbers
Q2 earnings are pulling back at the sharpest rate since the height of the pandemic.
Here’s FactSet, which is the go-to earnings data analytics group used by the pros:
Earnings Decline: For Q2 2023, the blended earnings decline for the S&P 500 is -7.3%.
If -7.3% is the actual decline for the quarter, it will mark the largest earnings decline reported by the index since Q2 2020 (-31.6%).
But Wall Street doesn’t like this type of analysis. Instead of looking at numbers in a vacuum, it prefers to reward or punish corporate earnings based on their performance relative to analyst expectations. And as we’ve explained here in the Digest, analysts nearly always set a low bar so that earnings can “surprisingly” beat expectations.
Don’t take my word for it. According to FactSet, the actual earnings growth rate has exceeded the estimated earnings growth rate at the end of the quarter in 37 of the past 40 quarters for the S&P 500. This doesn’t happen unless it’s intentional.
Analysts do this because they know their clients will be far more forgiving of earnings estimates that are too low rather than too high. This is what keeps the Wall Street gravy train going.
With this context, let’s turn to why this Q2 earning season, which is on track to post a blended earnings decline of -7.3%, is “surprisingly strong”
Back to FactSet:
At the mid-point of the Q2 earnings season for the S&P 500, the number of companies reporting positive earnings surprises is above recent averages, while the magnitude of these earnings surprises is below recent averages.
Translation – lots of analysts have done their part by sandbagging earnings, hence the “above average” number of companies reporting positive earnings surprises…
However, given the poor condition of earnings (-7.3% decline), these positive “beats” are only narrowly clearing their hurdles.
That said, a narrow beat is still a beat. And so, Wall Street has been chugging higher as you’ve probably felt in your portfolio.
If the second half of this earnings season plays out as we’ve seen so far, your portfolio will likely escape the -7.3% earnings decline not only without too many bruises, but potentially in better shape than it began.
Keep your eyes on Thursday afternoon when Amazon and Apple report after the bell. Those numbers will drive the market on Friday.
Meanwhile, though the market has been defying gravity in recent weeks, be ready for a short-term pullback
In yesterday’s Digest, we looked at why the S&P is overdue for a healthy breather. Monday’s analysis from The Wall Street Journal adds to our call for short-term caution:
The extra reward for holding stocks instead of bonds has fallen to its lowest level in 20 years, threatening a recent hot streak for major indexes.
One method for gauging the value of stocks is to compare their earnings yield—calculated by dividing a company’s expected earnings over the next year by its stock price—to the yield on government bonds, considered the closest thing to a risk-free return. The difference, sometimes called the equity-risk premium, shows how much investors are being compensated for the additional risk of owning stocks.
And right now, that isn’t much.
The gap between the earnings yield of the S&P 500 and the yield on the 10-year U.S. government bond dropped to around 1.1 percentage point last week, its narrowest since 2002.
If we look at market history, stretched readings like this don’t like to remain stretched for too long. Whether it’s a stock price that explodes higher overnight… a valuation that reaches depressed, gutter levels… or a rabid preference for one asset class over another… extremes tend to revert toward their means over time (though they can remain out-of-balance for longer than many investors can handle it financially).
Back to the WSJ making this point – which is why we continue to suggest investors be on the lookout for a short-term price correction:
…There is a consensus on Wall Street that the equity-risk premium can’t stay this low forever.
For stock prices relative to earnings to be back to where they were at the start of the 2022 selloff “when interest rates are 2x, 3x higher than they were really doesn’t add up,” said Tim Urbanowicz, head of research and investment strategy at Innovator ETFs.
On the other hand, last Friday’s Digest included counter-analysis from our hypergrowth expert Luke Lango that added more context to this stretched equity-risk premium (ERP).
Luke pointed out that though the ERP does show stocks trading at elevated valuations relative to the past 10 years, they are in-line with their averages from the 1990s – which he views as a fundamentally comparable period to today.
The similarity has to do with groundbreaking technologies that warranted higher stock valuations. In the 90s, it was the tailwind of the internet; today, we have an even greater gale-force tailwind…
Artificial Intelligence.
Where are we in the Artificial Intelligence investment cycle?
“Invest in AI!”
That’s the refrain echoing across the investment industry today.
But this vague exhortation isn’t very helpful. How, exactly, do we invest in AI today? And do AI stocks remain raging “buys” after so many leading AI stocks have seen massive price explosions this year? What about the ERP we just looked at? Does that suggestion caution?
Investing in any tech megatrend follows a progression. Knowing the progression (and where we are in it today) can help investors position their portfolio to be “at the right place, at the right time” so to speak.
For more, let’s go to Luke:
…Every new technological paradigm shift – like the one we’re seeing with AI – follows a similar pattern.
That is, these shifts evolve in three distinct “profit waves” …
The first profit wave emerges in the “picks and shovels” suppliers of the new tech – the companies that make the stuff that powers the technology.
The second profit wave emerges in the infrastructure makers for the new tech – the companies that take those picks and shovels and make new devices.
And the third profit wave emerges in the software and services developers for the new tech – the companies that create cool, usable applications on top of the new devices.
To illustrate, Luke points toward the mobile internet boom.
First, there was the profit explosion from semiconductor companies like Qualcomm Inc. (QCOM) that were selling the chips that powered smartphones.
Second came the boom in device-making companies like Apple Inc. (AAPL), that took those Qualcomm chips and made ultra-popular iPhones.
Finally, software and services companies like Alphabet Inc. (GOOGL) and Amazon.com Inc. (AMZN) exploded when their mobile internet applications found their way onto smartphones.
Luke provided the following graphic from Morgan Stanley to help illustrate:
We are still squarely in Wave 1.
Back to Luke for what this means:
The AI Revolution will play out no differently.
We’re already seeing the first profit wave emerge today. AI chip supplier stocks are soaring right now.
This boom will last for a year or so. Then, it’ll be the AI hardware makers who experience a profit surge. After that, the AI software developers will start to soar.
For more details on this AI roadmap, last week, Luke sat down with legendary investors Louis Navellier and Eric Fry for the AI Impact Event.
It was an enormous evening, with thousands of attendees joining in to learn how our experts are positioning their subscribers for profits today.
They also unveiled a brand-new AI focused portfolio of nine stocks they believe are poised for a huge run in the coming years as this AI roadmap plays out.
Circling back to the question above of “are AI stock still a ‘buy’ after the big run-up earlier this year?”, I just looked at the portfolio. Since last Thursday’s portfolio debut, one of the stocks is already up 55%, with a second up 29%. And the entire portfolio is up an average of 10%.
Bottom line: We’re still very early in this AI megatrend. You’re not too late.
Finally, this morning’s JOLTS report showed a slight tightening in the labor market, which the Fed wants to see
The Job Openings and Labor Turnover Survey (JOLTS) is a monthly report showing the number of job openings, how many workers were hired, how many quit, how many were laid off, and how many experienced some other “work separation,” such as a death.
The Fed watches this report closely as unemployment is a key factor in shaping interest rate policy.
So, what did it show this morning?
Here’s FX Street:
The number of job openings on the last business day of June stood at 9.58 million…
This reading followed 9.82 million openings in May and came in slightly below the market expectation of 9.62 million.
To a Fed that wants to tighten the labor market without crashing it, this is a good report. It’s a “slow taper” of jobs rather than a guillotine chop that would sound the “recession” alarm.
Bottom line: nothing here is likely to disrupt today’s bullish sentiment.
We’ll keep you updated on all these stories here in the Digest.
Have a good evening,
Jeff Remsburg
