So we know that markets were running hot over the last year and took a bit of a breather over the last few weeks. Its off about 5% from its all time high at the time of writing. Technically, we have referred to the rising wedge formation which appears ominous. But in contrast, it is the same wedge formation which has been providing ‘fake breakouts’ over the last year and has cost many a bear its hide.

Who knows?

Predictions are a mugs game. With all the moving macro parts is even more treacherous. And the truth is that regardless of what anyone tells you, no one REALLY ‘knows’. It’s why for new and old readers alike, you will know that Moe-Knows is an aspirational moniker. We are all learning, and we will continue to do so throughout life.

So in this vein, I decided to look away from the charts for a bit as we head into year another quarterly earnings season. I came across some interesting articles from FactSet which I will refer to here, but please feel free to check out their site here.

Another bumper season?

Let’s dig right in. Current data at the onset of the Q3 earnings season indicated that over the last 5 quarters, Actual earnings beat earnings estimates with the last ‘miss’ coming in Q1 2020 amid the first pandemic slump.

Estimate vs actual earnings quarterly

What’s also quite telling from the FactSet data and graph above is that earnings estimates for Q3 2021 are less than half what they were in Q2. This is global headwinds start to bite and as base effects start to get baked in.

So what’s the track record?

Analysts are remarkably bad at getting the earnings call right. Some of this is because of built in biases in how we assess stocks. I won’t go into detail on these mental models. Perhaps a topic for another day.

Table of analyst over/underestimation of index

What you need to know is that over the last 5 years, analysts have underestimated the index based on earnings expectations by around 1.7%. However, over the last 10,15 and 20 years, they have successively overestimated the index based on earnings estimates.

With that in mind, it is always worth taking the next chart with a pinch of salt. The chart below (also from FactSet) takes the median target price for all the companies in the index and ‘builds’ up to the index value to posit a view of where the index goes over the next year.

Chart of bottom up estimates of index level

Markets are forward looking


There are always several complexities to consider. Bear in mind that all market participants are generally looking at the same data and coming to their individual conclusions. That’s the beauty of what makes a market. As such, the earnings views above (Aggregated) should theoretically take in myriad of concerns we usually discuss on this blog into account already [inflation, growth, FED, China, etc].

However, given the dynamic of over/underestimation discussed above, perhaps a better way to consider this chart would be to ‘smooth’ the peaks and troughs? Perhaps this accounts for why the current market price is discounting the analyst’s underestimation on earnings and thereby implying a higher price in the spot market? What do you think, let me know via social media or email.

A bigger cliff to fall off?

A parting thought on this. If the market is already discounting a higher earnings estimate (assuming analysts underestimate in the current cycle), this goes a long way to explain the massive price pressure we see when companies miss what are lofty earnings estimates in some sectors. We saw some spectacular action during Q2 earnings with double digit declines in some big names.

Perhaps Q3 will represent ‘peak earnings’. Inventories have been run down, leading to massive windfalls for many companies. With supply chain constraints (keep your eyes and ears peeled for this week’s Magic Markets podcast where we discuss this), it may signal much tougher terrain ahead. The question is always, ‘what’s priced in’.

Chart Source: FactSet

These blog posts are commentary. There is ALOT more beneath the surface.

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