Earnings estimates continue to fall for 2020 and 2021 but likely haven't fallen enough as we find out more about the state of the US economy.

Earnings Estimates For The Stocks Are Likely Still Too High

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May 16, 2020

Stocks – None

Macro – SPY

Short-Term Trends – Cautious

Long-Term Trends – Bearish

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Stocks fell for the week of May 15 but managed to claw back some of the steep mid-week losses on Thursday and Friday. Volatility is picking up this week, and it seems reasonable to wonder if this is a turning point lower or higher for the market.

Elevated Values

Overall the market remains in an elevated state trading for around 25.5 times 2020 earnings estimates of $111.66 and 17.5 times 2021 earnings of $163.15. Still, the trends continue to remain lower, and based on those earnings, it seems that expectations of a “V” shaped recovery are being priced in. The chart below shows the change in quarterly earnings year over year, but not on a trailing twelve-month basis.

eps trends

Currently, we can see that the estimates are showing that earnings would have troughed in the first quarter. However, previous years have taught us that forecasts tend to come down over the year and that those expectations tend to get pushed further into the future. The image below is from a story I wrote on March 21, 2019. It shows that earnings were expected to have troughed in the first quarter at that point too. However, history exhibits in the chart above that earnings didn’t’ actually trough until the third quarter of 2019.

Meanwhile, as I noted here, in February 2018, estimates for 2019 were expected to be $172.10 per share, but we know by the time 2019 was complete, earnings were actually around $157, a whole 8.8% less. So if current trends play out, we can probably expect earnings estimates to be too high and are likely to trough at some time in future quarters like the third or fourth quarter.

Too High?

Another concern I have about these earnings trends is that in 2008 the GDP contracted at 4% on y/y basis in March 2009, which was the trough, but earnings fell by a stunning 43%. While in the 2001 recession, GDP growth was flat on a y/y basis, and earnings fell by around 30%. Are we really to believe that with GDPNow estimates a 42.8% annualized rate of decline in the second quarter and earnings shall drop by just 30%. The chart below shows the change in earnings on a year-over-year trailing twelve-month basis.

Quickly for those that don’t know, the way GDP calculation works, they use the change from the previous quarter on an annualized rate. So for example, the first quarter GDP fell by 4.8%, but if you divided that by 4, it means that GDP in the first quarter fell by 1.2% from the fourth quarter value. Therefore, if there is a 40% decline at the annualized rate, it would equal a 10% decline from the first quarter results.


One last way to look at current earnings protections is by taking operating earnings and dividing it by total US GDP. In this chart, I show that operating earnings as a percent of GDP fell to around 2.3% in 2008. In this recession, current operating earnings are suggesting they represent just 5.2%. That is basically in line with that mini-earnings earings recession we saw in 2015 and 2016 when the US economy was still growing.

In my model below, I am assuming that GDP will grow at a 10% annualized rate in the third quarter, 6% in the fourth quarter, and then at the longer-term trend of 3% through the end of 2021. It suggests that earnings as a percent of GDP falls to around 5.2% in the fourth quarter of 2019, and rebounds to a record high 7.4% of GDP in 2021.


Again, this seems highly unlikely given the sharp contraction in the GDP. Additionally, without forward guidance from many companies in the S&P 500, it is highly likely that many companies could disappoint in the second quarter, dragging estimates sharply lower.

These are currently some of the factors I am considering and will continue to modify my assessment as more economic data become available this week.

Have a great weekend!

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