Broker Check

Earnings Season is Stronger Than it Appears

| February 12, 2024

We’re about halfway through earnings season for 2023’s fourth quarter, so let’s check the underlying data to determine corporate America’s strength. On the surface, overall performance relative to estimates looks subpar. But our deeper dive will show how earnings season is stronger than it appears.

Most of the earnings underperformance at this point was due to a high number of companies in the financial sector that reported results at the start of earning season. However, over the past three weeks, the numbers have improved significantly as other sectors reported, and the S&P 500* is now reporting earnings growth for the second consecutive quarter:

As of this writing, 46.0% of companies reported actual results. Of those, 72.0% reported earnings per share greater than analyst estimates by an average of 2.6%. Importantly, by Jan. 19, financials companies were done reporting. Since then, 75.0% of the companies reporting have beat EPS estimates by an average of 7.3%.

In terms of revenues, 65.0% of S&P 500 companies have reported revenues above estimates by an average of 1.0%:

Most importantly, so far the 2023 fourth quarter blended revenue growth rate is 3.5%. That’s up from 3.1% in mid-January. Moreover, analysts now expect earnings growth of 4.5% for this year’s first quarter alone and earnings growth of 11.2% for 2024. This, along with corporate data, shows how we’re past the earnings trough of early 2023.

The improvement in earnings since Jan. 19 is because the financials sector completed reporting – from Dec. 31, 2023, until Jan. 19, 2024, the blended earnings rate for the financials sector fell from -2.2% to -19.2%. But after Jan. 19, positive EPS surprises led to an increase of $16 billion in earnings. Companies like Microsoft, Apple, Qualcomm, Intel, Meta, Alphabet, and even energy companies like Exxon and Chevron, helped push the market higher # ^.

These surprises provided the strength for earnings growth to continue its acceleration from the trough we experienced last year. Alas, earnings are stronger than they appear on the surface. We think there are three main reasons for the mirage.

First, the financials sector’s woes are a result of a nearly $23 billion charge from the Federal Deposit Insurance Corporation on the industry to clean up the Silicon Valley Bank mess. So, the sector’s recent drop was likely a one-time hit.

Excluding the $23 billion assessment, overall EPS is tracking to 3.6% greater than quarterly expectations (more than the long-term average beat of 3.2%):

Next, the market reaction to earnings is the best since the fourth quarter of 2022. Companies beating estimates are seeing one-day stock gains of 1.1%, which is greater than the 0.8% from the third quarter of 2023 (see chart below). This reflects a normalization from the recent past, when a “positivity premium” was also needed to boost stocks after successful earnings announcements.

Lastly, the percentage of companies reporting greater than 10.0% EPS growth continues to increase. To us, that solidifies that the first quarter of 2023 was the end of the EPS recession:

Let’s keep in mind though how we're 14 weeks into this current rally. The last two extended rallies were 16 and 19 weeks, respectively. Also, MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of all “big money” professional investor buys and sells, recently fell from the overbought level:

Our readers know that when the BMI dips from overbought, consolidation and short-term volatility tend to follow. So, a near-term pullback wouldn’t surprise us and will offer attractive new entry points if planned for appropriately.

Artificial Intelligence, Real Growth

After big equity market moves since late October, many investors wonder what could keep the upward trajectory going. We think it will be AI.

There is a growing belief that hyperscalers’ demand for AI chips is just the beginning of a multi-year transformation of nearly every industry and the economy. Some even argue AI will be a bigger transformation than the internet itself. In our view, the growing bullish sentiment surrounding AI is supported by emerging data regarding its actual applications.

One thing we can agree on is there's little argument that AI will have huge positive impacts on economic productivity and efficiency. It will likely be accretive to global gross domestic product and perhaps energize growth quicker than many think possible at this point.

For instance, consulting firm McKinsey & Company estimates AI could add $13 trillion to the global economy by 2030. That’s comparable to the internet’s economic effect in the last two decades. Additionally, the analysis indicates AI could boost productivity by 40.0% and generate up to $9 trillion in annual value from innovation. Such upside has attracted huge private investment:

More interestingly, AI investments in the U.S. significantly outpace other superpowers:

Per the above article and chart, it’s clear the adage is true – “America innovates, China replicates, and Europe regulates.” This data supports our thesis that concentrating our investments in the U.S. versus the rest of the world is long-term bullish.

So, what sort of innovations and profits will AI deliver for businesses? Here are some examples:

  • Customer service via AI-powered chat bots.
  • Cybersecurity and fraud management, where AI can detect and prevent threats by analyzing large swathes of data to identify anomalies.
  • Content production, including AI-developed marketing materials, product descriptions, and more.
  • AI-driven inventory management that can reduce waste and forecast demand.
  • Streamlined recruiting through faster resumé screens, interviewing, and skill assessments.
  • Machine learning that enables machines to learn from data and improve performance.
  • Complex data pattern and relationship identification through deep-learning neural networks.
  • Reinforcement learning that helps machines learn from and train each other.

We think the most impactful changes will come from machine learning AI. Its current value of nearly $100 billion is expected to grow 20-fold by 2030:

Now, we must recognize how AI poses significant challenges and risks. Some include ethical dilemmas, job displacement, and security threats. Investors cannot ignore these dangers. Still, anyone who missed out on internet stock fortunes should have a fantastic opportunity to benefit from the potentially explosive growth of AI going forward.

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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

# Cornerstone owns Microsoft, Apple, Qualcomm, Meta, Alphabet, Exxon, and Chevron in managed client accounts.

^ Daniel Milan owns Microsoft, Apple, and Meta personally.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.