S&P 500 earnings record is on line with peak growth

Bloomberg

All through the pandemic era, buying stocks when corporate America delivers its quarterly reporting card has been a reliable winning trade. But the streak may be coming to a close.
While second-quarter profits may look robust when banks start reporting on July 13, the forecast earnings increase of 64% for all firms in the S&P 500 Index probably marks the pinnacle of this expansion cycle. That’s adding to concerns that everything that has bolstered this 15-month bull market, from an economic boom to massive policy support, is poised to lose steam.
If history is any guide, equity bulls have reasons to worry. Peaks in profit growth tended to foreshadow subpar performance in stocks, almost a century of data compiled by S&P Dow Jones Indices and Bloomberg show.
A potential economic slowdown, the spread of a highly contagious coronavirus variant and the specter of Federal Reserve scaling back monetary stimulus have prompted Cumberland Advisors to recently raise cash holdings in its portfolios.
“We’re a little more defensive,” said David Kotok, chief investment officer at Cumberland. “We would like to see the optimistic outcomes, but we think the risk profile in the world is rising.”
Signs of a weakening economy have rattled financial markets in recent weeks, contributing to a drop in 10-year Treasury yields. Meanwhile, economically sensitive shares like banks have lost some luster while steady growers such as technology are back in vogue.
After second-quarter results finish rolling out, income growth for S&P 500 firms is forecast to slow in each of the next three quarters as the boost from government stimulus winds down and the base effect from the pandemic recession fades. By the start of next year, the pace of profit growth will dwindle to less than 5%, a fraction of what’s expected to be the fastest expansion in more than a decade for the quarter just ended, data compiled by Bloomberg Intelligence show.
Similar post-peak periods haven’t boded well for stocks in the past. Since 1927, when earnings momentum started waning, two-thirds of the time the S&P 500 fell or performed worse than usual in the following quarter.
The latest example came after President Donald Trump’s tax cuts boosted corporate earnings in 2018. Growth topped out in the third quarter of that year, right before the S&P 500’s 14% drop over the next three months.
With stocks now trading near the highest price-earnings multiples since the dot-com era, there is little room for error. And yet from President Joe Biden’s proposed tax hikes to pricing pressure from higher costs of labor and raw materials, the threat to corporate bottom line isn’t insignificant, according to Tobias Levkovich, Citigroup Inc.’s chief U.S. equity strategist.
“There is excessive complacency in the market currently, as too many people we talk to think a smooth transition from monetary policy support to that of earnings will play out. We are less certain,” Levkovich wrote in a note earlier this month. “We can see the convergence of profit-margin pressures, inflation fears, Fed tapering and taxation contributing to a drawdown.”
The complacency is understandable. Earnings season has been a boon for equity bulls since the start of the pandemic as companies crushed expectations through strategies like cost reductions. The S&P 500 advanced each reporting period, rising an average 4.6% during the six-week stretch.