A critical driver of bull markets has stalled

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Tue, Mar 30, 2021, 3:26 AM3 min read

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Tuesday, March 30, 2021

Wall Street earnings forecasts were revised down last week

March ends this week, which means we'll get monthly economic reports showing just how much the U.S. economy rebounded following February's weather-driven slowdown and the ramp-up of COVID-19 vaccinations.

Preliminary data suggests the spring spending binge is here, fueling substantial job gains.

For investors, the question is to what degree the good news today and the optimism for the future is already priced into the market.

Morgan Stanley's chief U.S. equity strategist Michael Wilson thinks maybe all of it.

"Running with the bulls can be dangerous," Wilson said on Monday. "At this point, the bullish narrative of a recovering/reopening economy is very much the consensus view. That doesn't make it wrong, but markets are discounting machines and may already reflect the recovery from last year's sharp recession."

This comes as new data compiled by FactSet suggest analysts' sentiment toward future earnings may be turning.

"With US equity multiples as high as they are (21.6x forward 12-month earnings) you do not want to see Wall Street analysts cutting their estimates, but that’s exactly what happened last week," DataTrek Research co-founder Nicholas Colas observed in an email on Monday.

Colas shared the chart below from FactSet, which shows analysts' forecasts for 2021 and 2022 S&P 500 (^GSPC) earnings.

"You can see the dramatic estimate cuts from the Pandemic Recession (March – July 2020), then all the upward revisions thereafter," he wrote. "You can even see where Tesla went into the 500 (that December dip). For stock market investors, a critical metric to watch is expectations for future earnings." (Emphasis ours.)

Forward earnings estimates ticked down. (FactSet) (Yahoo Finance)

Colas doesn't think this is cause for alarm yet.

"Takeaway: we’re chalking up this reversal to near term noise ahead of Q1 earnings season," he wrote. "Analysts have been raising their estimates consistently and against the usual pattern of reducing quarterly estimates going into reporting season."

Indeed, one of the themes we've been covering in the Morning Brief has been equity analysts being slow to adjust their forecasts to reflect a better-than-expected business backdrop (See here, here, here, and here.) In fact, it was exactly a year ago that we were talking about analysts being slow to adjust to the worse-than-expected backdrop (See here, here, here, and here).

Last week, Credit Suisse's Jonathan Golub noted that historically, this "important tailwind" of upward revisions to earnings estimates early in recoveries lasted two to three years. So, it's quite possible that there are some upward revisions to earnings estimates in the pipeline. Maybe it's the case that analysts have decided to just wait for quarterly earnings reports later in April to inform their next published update to their financial models.

"[T]his bears watching as we start to see actual Q1 results in a few weeks’ time," Colas wrote. "At this point in the capital markets/economic cycle, stocks follow the direction of earnings revisions. The chart above needs to continue to go up and to the right to keep the US equity market rally intact."

By Sam Ro, managing editor. Follow him at @SamRo