Annual Reminder: Earnings Are a Lagging Indicator

by Scott Wren, Senior Global Equity Strategist

Key takeaways

  • The market knows earnings results in the second quarter are going to be poor. We are slightly more optimistic than the consensus and see flat comparisons.
  • Keep in mind that earnings only tell us what happened in the very recent past. They do not tell us what will happen in the future.

Download the report (PDF)

We are in the very early stages of the second-quarter reporting season as less than 5% of companies have posted results. The reporting pace will pick up significantly next week in what will likely be a second consecutive disappointing earnings season. Consensus expectations are calling for a year-over-year decrease of 2% to 3%, but we would not be surprised to see an actual outcome similar to last quarter’s virtually flat (zero) result. The market, at this point, doesn’t appear to be overly concerned with another poor quarter of comparisons. So in other words, for the overall market, investors will likely be more focused on trade headlines and other more macro events (i.e., potential Federal Reserve rate cuts).

Of course, earnings season attracts huge media attention. But in a modest-growth economy that features low inflation, most individual company analysts have an easier time confirming the guidance their companies are giving out. Sure, there will be the usual big positive and negative surprises coming from a relatively small number of individual companies but not so much from the overall market. Remember that company guidance nearly always leans toward the conservative side. That is why, quarter after quarter, it is common for 65% to 70% of companies to beat the consensus “Street” estimate.

It is when the economy is meaningfully either ramping up or slowing down that earnings get tougher to predict, especially when things are moving quickly in a direction that is different from the recent trend. Under those conditions, even the companies themselves have a hard time issuing accurate guidance to the analyst community. And when the future is uncertain, you can bet that very few companies will go out on a limb and tell investors that everything looks good—even if they think it does. The modest-growth/modest-inflation environment could easily be with us for the next 12 months or more. Investors around the globe realize this. While growth here at home may be below trend, it looks to be dependable as companies have figured out how to make money in the current environment. And note that we look for earnings to grow just over 3% in 2019 to another record high.

Keep in mind that earnings do not tell investors what is going to happen in the future. They merely tell the story of what happened in the very recent past. We look at the current earnings season as more of a process of confirmation. Second-quarter earnings should confirm that our outlook for the economy is on track and below-trend growth is likely to continue over the next four quarters. As we have pointed out many times in numerous cycles, this is not the end of the world. Stocks can do well in a modest-growth environment. However, based on current valuations and uncertainties, we are not looking for much net movement in the S&P 500 over the coming 12 months. So do not get caught up in the earnings-season hype. A big earnings surprise, one way or the other, for the overall market is likely not in the cards this quarter. Focus on how the economy will drive corporate outcomes in the future because earnings are a lagging, not leading, indicator.