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Some investors and strategists have remained befuddled at the stock market's ascent this year.
Corporate America entered an earnings recession in the first quarter, and even the already-bleak expectations for a second-straight decline in profits were deemed too optimistic.
Back in April, we highlighted work from Barclays that suggested estimates for 2023 earnings were still about 10% too high.
In other words, economic reality was due to eventually meet investors and management teams where it matters most for stock prices: the bottom line.
But a curious thing has happened in the intervening months.
While AI-related hype has driven stocks higher and captured the headlines, fundamentals have also turned around.
At the beginning of first quarter earnings season, analysts expected to see a 6.8% drop in profits from the prior year. By the end of the season, S&P 500 companies reported earnings per share that were down 2% from last year.
And market history tells us it should come as no surprise a better-than-feared quarter has powered stocks higher.
Or rather, that a stock market defying expectations by rallying in the first half of 2023 was signaling to analysts that earnings would likely need to be revised higher.
In a note to clients published Monday, RBC equity strategist Lori Calvasina highlighted the five charts that defined the first half of the year for her team.
And among them was the following chart, which shows earnings revisions turning positive — meaning more earnings forecasts were being revised higher than lower — tends to follow a stock market that has already bottomed out.
Looking through very recent market history, the S&P 500 reached a local bottom three to six months before earnings estimates turned higher in 2016, 2018, and 2020.
And it appears 2022-23 — in which the index bottom near ~3,570 in October 2022 and earnings revisions turned higher in May — will fit the same pattern.
"One argument that has really bothered this lead author this year is the idea that the S&P 500 needed to retest the October lows because earnings estimates were too high," Calvasina wrote. "Experience has taught us that stocks are discounting mechanisms and often price big things in ahead of time."
Calvasina noted the three to six-month timeframe was "a little off" this time around, but the 7-month gap between the market hitting its recent low and earnings revisions turning positive still outlines the core lesson for investors: stocks rally before the fundamental backing for the rally becomes obvious.
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