Stock prices are affected by many different factors.
So many, in fact, that it’s hard to list them all.
Economic growth, the labor market and wages, inflation, consumer and business sentiment, government spending, the health of our trading partners and export markets, politics and regulatory policy, the Federal Reserve and interest rates, bond yields…
Heck, even the weather can move stocks.
Luckily, you can boil all of those factors down to a single data point that predicts where stock prices will eventually go.
I’m talking about corporate profits, also called earnings.
If the economy is growing, people are employed and taking home better pay, inflation is under control, consumers and business managers are optimistic, exports are healthy, and the Fed is not hiking rapidly, then well-managed companies will grow their earnings.
And as Chief Investment Strategist Alexander Green so often reminds us, stock prices ultimately follow earnings.
Sure, in the short term, stocks can move up or down as a result of many influences – sometimes even randomly. But in the medium and longer term (which should be your time frame unless you’re a day trader), earnings are the primary driver of a stock’s price.
So today I’ve got encouraging news for investors: The outlook for earnings for the remainder of 2023 is only getting better.
In both July and August, company analysts increased their earnings estimates for S&P 500 companies, according to the latest update from FactSet, which tracks earnings.
As a result, for the third quarter (ending September 30), the median estimate for earnings per share for the S&P 500 was bumped up by 0.4%.
That’s a relatively modest increase. But here’s what’s interesting about it: In the first two months of any given quarter, analysts typically reduce their earnings estimates. In fact, over the last 20 quarters, they’ve reduced their estimates by an average of 3%.
But not this quarter. And the fourth quarter is looking even brighter from an earnings perspective. Analysts expect earnings to grow more than 8% year over year.
Don’t Worry, Be Happy
Even better, companies are becoming leaner and meaner. By that, I mean they’re improving their profit margins.
S&P 500 profit margins rose in the second quarter to 11.9%, which is higher than in the first quarter – and well above the historical average of 8.9% since 2000.
Finally, companies are a lot less worried about a recession now than they were a year ago.
How do we know that? Because they’re not talking about it anymore.
The number of S&P 500 companies mentioning the word “recession” during their quarterly earnings calls has plummeted over the past four quarters.
As you can see in the chart, the number of executives mentioning the R-word peaked in the second quarter of last year (at 238). A year later, that fell to just 62 out of 500 companies.
When companies think a recession may be coming, they’re more likely to cut costs, which can mean layoffs and reduced capital spending on things like buildings, vehicles, equipment, software, etc.
But with recession worries falling rapidly, we can expect the opposite: beefed-up hiring and more capital spending. And that’s already been happening. Six in 10 companies in the S&P 500 increased capital expenditures year over year in the second quarter.
More capital spending means more revenue, higher margins and, eventually, earnings growth.
It’s all very good news if you own a piece of these companies through their stocks.
So keep investing… wisely.