Why Better-Than-Expected Earnings This Reporting Season May Struggle to Boost the Market Any Further

## The Trough of Earnings is Approaching: Good News or Bad News? The second quarter of the year is expected to be the trough for earnings, which is good news. However, the problem lies in valuations rather than earnings themselves. Valuations are currently very high, and this may prevent stock prices from moving forward even if earnings reports exceed estimates. Analysts have lowered their estimates for the second quarter, but not significantly. Strategists, including Savita Subramanian at BofA Securities, believe that the second quarter will be the trough for earnings, and analysts' estimates support this. The outlook for the rest of the year is not as dire as it was six months ago. The feared earnings "apocalypse" and a serious recession in 2023 have not materialized. Instead, we have seen a soft landing scenario where inflation is slowly decreasing, job growth is moderate but healthy, and corporate profits are stable and slowly improving. The issue lies in valuations. The market has seen significant changes over the past six months. The S&P 500 has increased by 15% since early January, primarily driven by technology, communication services, and consumer discretionary stocks. However, earnings expectations for 2023 have remained essentially the same. This means that the rise in stock prices is due to multiple expansion rather than a substantial increase in earnings estimates. Currently, the S&P 500 is trading at over 19 times earnings estimates for the following four quarters. This is not a "recessionary" multiple, but rather one typically associated with an expanding economy. It is also considered rare territory, ranking in the 84th percentile since 1985. The high valuation presents a challenge for investors as it makes the S&P 500 at 4,400 with forward earnings at $230 less appealing than it was in January when it was at 3,800 with forward earnings at $220. With higher stock prices, even positive earnings reports may struggle to move the markets significantly. Chris Harvey from Wells Fargo suggests that exceptional earnings results and guidance will be needed to push the market higher, and a "sell the news" reaction may be more appropriate. While some companies have exceeded expectations by a wide margin, others have only achieved modest beats or even had their second-half estimates reduced. The expansion of the S&P 500's multiple can be attributed to the extraordinary gains of a small number of tech stocks, such as Apple, Microsoft, and Nvidia. The forward P/E ratio for the S&P technology sector is currently at 27.2, well above its 5-year and 10-year averages. In contrast, the valuations of eight out of the remaining ten S&P sectors are either lower or only slightly higher than the average for the last five years. To achieve overall market growth, it is crucial for the market to broaden out beyond a few dominant tech stocks. Investors should look for opportunities outside of Big Tech and allow other sectors to catch up after lagging in the overall market year to date. ## Conclusion: Implications for New Businesses in a High-Valuation Market The approaching trough of earnings brings both good news and challenges for new businesses entering the market. While it is positive that the second quarter is projected to be the bottom for earnings, the real hurdle lies in valuations rather than earnings themselves. Valuations are currently very high, driven by the extraordinary gains of a select few tech stocks, which may hinder stock prices from moving forward even if earnings reports exceed estimates. For new businesses, this high-valuation market presents a nuanced landscape. On one hand, the market has seen significant changes and has been driven by technology, communication services, and consumer discretionary stocks. However, the valuation of these sectors, particularly in the tech industry, is currently well above historical averages. This means that investors may be more cautious in allocating capital to these already high-priced stocks. As the market seeks to broaden beyond a few dominant tech stocks and achieve overall growth, new businesses outside the tech sector may find opportunities to catch up and gain investor attention. This presents a potential avenue for new businesses to stand out and attract investment. However, they must prove their value and demonstrate exceptional earnings results and guidance to overcome the high valuations and generate substantial market interest. It is essential for new businesses to carefully navigate this environment and leverage their unique selling points to stand out amidst the dominance of big tech players. They should focus on providing innovative solutions, demonstrating a strong growth trajectory, and targeting sectors that have been relatively undervalued compared to the tech industry. Ultimately, new businesses entering the market during the trough of earnings must be prepared to face the challenges posed by high valuations. By understanding the market dynamics, targeting the right sectors, and showcasing their value proposition, they can position themselves for success and navigate this unique market landscape in pursuit of growth and investor attention. Article First Published at: https://www.cnbc.com/2023/07/13/why-better-than-expected-earnings-this-reporting-season-may-have-trouble-boosting-market-further.html