'It's almost not even within the realm of possibility,' says strategist about trend in analyst earnings estimates
Earnings revisions are unusually rising at this point of the year.
Macro and geopolitical news are likely to sway financial markets until the next earnings season starts in earnest in mid-October. And investors may have underappreciated just how strong second-quarter earnings were, according to Patrick Palfrey, head of portfolio strategy at Seaport Research Partners, a Chicago-based research firm staffed by many ex-Wall Street veterans.
In an interview with MarketWatch, Palfrey pointed out that S&P 500 earnings per share jumped 55% in the second quarter, or a still-impressive 35% when stripping out unrealized gains. "It's being driven obviously by the technology companies, semiconductors in particular, but generally speaking, the backdrop for profits remains very, very robust," said Palfrey, who joined Seaport with fellow UBS strategist Jonathan Golub last year.
He credited the artificial-intelligence build-out as well as the growing need for energy, even excluding the run-up in oil prices due to the war in Iran. The median company in the S&P 500 SPX grew earnings by a "tremendous" 15.5%, which he said was the core reason the firm is as positive on the market as it is.
Analyst earnings revisions, he noted, are unusually growing at this stage. "Typically the way revisions happen, they start at an elevated level and then they tend to fall over the course of the year, or over the course of the quarter, into the reports," said Palfrey.
"The fact that we're up is such an anomaly," he said. "It's almost not even within the realm of possibility - that's how strong the corporate backdrop has been."
Granted, while earnings expectations are important, investors also have to decide what multiple to assign to them. "The higher interest-rate backdrop that we are experiencing is ultimately damaging the cost of capital and is going to pressure [price-to-earnings multiples], and that's one of the reasons that we've been seeing multiples come down over the course of this year," he said. Another factor weighing on multiples is investor doubt that the profit backdrop will remain this healthy.
He pointed to the turmoil software companies IGV faced earlier this year on worries over AI disruption. "The verdict was that they were all guilty before anyone did due diligence, and then they rotated back into favor," said Palfrey.
Seaport has a series of charts it produces, comparing the three-month change in earnings per share expectations to the three-month price move, to identify companies with "justified" and "unjustified" moves. He said the firm is seeing dislocations in industrial and transportation companies in particular. "The stocks aren't being rewarded adequately for the acceleration of those fundamentals," he said. Technology is capturing not just all the capital investment but also the attention from investors, he said.
Seaport held a call with institutional investors this week and the issue they kept coming back to was the interest-rate backdrop. "That's really the area where we used to try and have the conversation in meetings, and investors would just say, 'another day, another day, another day.' And all of a sudden we finally arrived at a day where the move in the interest rates, the hurt to the cost of capital, the decline in PEs, and then of course demographics is now entering the conversation in a more robust way."
Next week's Federal Reserve decision may still surprise investors, even with expectations running around 60% that the central bank will hike rates. "The idea you could have a conversation around inflation and the need to hike would potentially be quite a shock," he said. On a day-to-day basis, the economy doesn't matter too much to stock-market investors as they bet on the AI build-out. "I think bringing [a rate-hike discussion] to light will continue to just put a little bit of cold water on equities over the near term."
The market
Stock-market futures (ES00) (NQ00) were mixed. Brent crude (BRN00) was trading around $102 per barrel.
Key asset performance Last 5d 1m YTD 1y S&P 500 7636.36 -0.39% -1.45% 11.55% 16.91% Nasdaq Composite 26,253.34 0.14% -1.26% 12.96% 19.95% 10-year Treasury 4.861 8.80 21.40 68.90 83.10 Gold 4438.2 -1.82% 0.71% 2.45% 20.83% Oil 97.43 6.28% 19.97% 69.71% 56.54% Data: MarketWatch. Treasury yields change expressed in basis points
The buzz
Producer price data are set for release at 8:30 a.m. Eastern, alongside weekly jobless claims. Existing-home sales data are due at 10 a.m.
The Treasury Department is due to buy back some $6 billion of longer-term debt.
President Donald Trump on Wednesday night proposed a $5,000 per adult handout, contingent on Republicans winning both chambers of Congress.
Oracle (ORCL)- the poster child for worries over the cost of the AI build-out - reports fiscal first-quarter results after the close, as does software giant Adobe (ADBE).
Starbucks bets $1 billion on coffee house antidote to lonely digital lives.
The chart
UBS precious metals strategist Joni Teves plotted the gold price to the expected change in interest rates to argue that Fed expectations don't matter quite as much now to the yellow metal's direction. "It suggests that the market has already absorbed a substantial tightening in expectations and is placing greater weight on why investors want gold in the first place. We would expect a September hike to generate a knee-jerk correction, but not to derail the broader recovery," said Teves.
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