What To Expect From The S&P 500 (NYSEARCA:SPY) Q4 Earnings Cycle

Why Earnings Might Not Lift The Market

There is a lot of expectation built into the market right now, and a lot of risk hanging over it. The rebound was much stronger than expected, earnings have been much better than expected, and that is all getting priced into the market. With the Q4 reporting season about to kick-off, there is reason to believe that earnings for the S&P 500 (NYSEARCA:SPY), however good they may be, are not going to be good enough to keep the rally in gear.

Three Reason’s The S&P May Move Lower In Q1

1) The Consensus Targets Are Off, But We Know This Already - The consensus targets for earnings have been off all year and are still not in-line with the reality of the economic situation. Not only were the downgrades too deep but the rebound in consensus has been too slow leaving the average company in a perfect position to beat its targets. While the consensus for Q4 earnings has been on the rise it has come nowhere close to matching the difference between pre-season consensus and final results for the S&P 500 over the last two reporting cycles. The consensus for earnings in Q4 is up only about 500 basis points from its low while Q2’s final results rose 1300 basis points from the low and Q3’s 1900 basis points. My point is that the market is expecting the average S&P 500 company to beat consensus by a fair margin so it will take more than just a little to really get it excited. In other words, the Q4 season is setting up to be a sell-the-news event unless results are much, much better than currently expected.

2) The Valuation Is Very High - The S&P 500 is trading at a very high valuation, nearly 23X its forward earnings, and that is another point of potential weakness. Not only is the index trading above its five and ten-year averages but it is trading above the high set at the end of the Q3 cycle and above the levels, it was trading just before the pandemic set in. Just before the pandemic set in, we here at Marketbeat felt the market to be overvalued and ready for a pullback if not a deep correction or bear market. In a sense, the high valuation is a good thing because it implies strengthening economic activity and rising income for America’s largest corporations. The catch-22 is that the market may have gotten ahead of itself. If the S&P 500 fails to match what we believe to be a very rich valuation, or at least the hopes of one day matching it, the price of stocks could come crashing back to reality. My point here is that if the market starts moving lower momentum could easily build.

3) The Technicals Are Not Encouraging - On a technical basis, the S&P 500 looks extended, it’s that simple. The index has been trending strongly higher on a melt-up of earnings, data, and analyst sentiment that may have run its course. Not only is the index nearly 10% above the 150-day moving average but the indicators show a growing weakness. To start, the MACD is highly divergent from the new all-time highs which are enough by itself to indicate weakness. Add to that a persistent overbought condition in both the MACD and stochastic oscillators that suggests the possibility of a major correction if not the actuality.

It’s Not All Bad News For The S&P

As bleak as it may sound the 4th quarter cycle will not be without its good news. The index is in fact expected to deliver sequential growth and above the current consensus if not a wee bit of YOY growth as well. Looking beyond that, the trajectory of earnings remains positive and the outlook continues to brighten. The consensus targets for both the Q1and Q2 periods of 2021 are on the rise as is the full-year target. The Q1 and Q2 consensus targets are up about 200 basis points each while the full-year implies high-double-digit YOY gains in the second half of the year.

The Technical Outlook: The S&P 500 May Go Range-Bound

The bad news is that the S&P 500 is set up for a fall. The good news is that this fall is an expected pullback within an otherwise bullish market. Although the market may have gotten ahead of itself in terms of valuation and expectations the outlook is good, the trajectory for earnings growth is upward, and so is the trend of analysts’ revisions. What this means in the near to short-term is a market that may pullback, consolidate, and even trend sideways for a time. What this means in the long-term is a chance for the S&P 500 earnings to catch up with the valuations. When stocks are down it’ll be a good time to add to winners, when stocks are up it’ll be a good time to lighten up on losers.