Stock prices keep rising even as corporate profit outlooks keep getting weaker

Published Mon, Dec 5 20228:05 AM EST

It's good to see stocks rally going into December, but the continuing decline in earnings estimates is worrisome. Since the start of the quarter, fourth-quarter earnings estimates for the S & P 500 have gone down 5.6% to $54.58 from $57.79, according to FactSet . It's fairly typical for earnings to come down a bit as the quarter goes on, but this decline is much more than usual. For example, the average decline in the first two months of the fourth quarter in the last five years has been only 2.1%, and only 2.7% over the last 10 years. We're seeing twice that decline now. Earnings are now expected to decline slightly for the quarter compared to the same period last year. 2023 earnings estimates are also coming down at a fairly rapid pace. Earnings are now expected to be up only in the low single digits. The problem is that estimates have been coming down at the same time stock prices have been going up . The S & P 500 is almost 15% above its October closing low. As a result, FactSet notes, the P/E ratio has expanded to 17.6 from 15.2 at the end of September. Seventeen times forward earnings is the historic average, but now that the multiple is moving toward 18 and higher, stock market bulls are going to have to make a strong argument for an economic soft landing to justify a multiple this high. How accurate are these analyst estimates? FactSet noted that on average analysts have overestimated yearly earnings by about 7% over the past 25 years. That's a fairly large overestimation, and it goes to a critical point: Analysts are optimists by nature. Analysts have far more buys than sells on their stocks. Why? Aside from being optimistic, it's likely a better career move to be overly bullish than overly bearish. That 7% overestimation may not be as large as it sounds. FactSet notes that there were four years where analyst estimates were off by more than 25%: 2001, 2008, 2009 and 2020. These years are associated with events that analysts would not have been able to predict: the 9/11 attacks in 2001, the financial crisis in 2008-2009 and the Covid pandemic in 2020. Removing those four years reduces the over-estimation from 7% to 2%. That's not bad, considering analysts are trying to predict events up to a year in advance.