Earnings Revisions Fall While Stocks Rally - Worst Case Scenario

Earnings Revisions - Estimates Weaken

Just because earnings season is over doesn’t mean earnings estimates don’t matter.

Since investors are always projecting future cash flows, estimates always matter. They aren’t set in stone. The rate of change of estimates gives us an idea of where the economy is going and where stocks should be headed.

It’s one part of my analysis and all the analysis for investors who don’t believe in following macroeconomics.

As you can see from the chart below, Q2 ended up with 26.58% earnings growth which is fantastic. It doesn’t matter much now though.

The estimates for Q3 have been declining as they peaked at 23.82% on July 1. They now show earnings growth of 22.27%.

(Click on image to enlarge)

Earnings growth has always been expected to peak in Q3. Now it looks like results will need a substantial beat to get above Q2 growth.

That’s not a huge deal either way because as long as earnings grow, stocks should be fine. If earnings growth misses or beats the rate in Q2, the media will be discussing the peak in growth just like it did in Q1. However, with more fervor, because Q4 is going to have start a sharp declaration.

Earnings Revisions - The most important aspect to understand is that Q4 earnings estimates are already important for forecasting equity performance. 

It’s ridiculous to think the stock market is going to correct based on something most investors knew 6 months ago. Everyone knows Q4 growth will be in the teens, but where it ends up is important.

The rate of change is important because stocks become more expensive if earnings growth is 15% instead of 19%.

As you can see in the chart below, investors are in a perilous situation because the stock market is near its record high. Also, there are many negative earnings revisions and few positive ones.

The situation is even worse than January which is disconcerting since stocks fell 10% after that peak. It took until August for them to recover. The upside is certainly capped for stocks unless the fundamentals improve.

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