The Bar Is Low Heading Into Fourth Quarter Earnings

Stock-market pessimists are about to face their next big test…

Throughout my life, I’ve always enjoyed competing. No matter what type of sport I’ve played, I like the thrill of testing myself against others to see the progress I’ve made in training. It tells me whether I need to push harder, or I’m headed down the right path.

But there’s a particular experience I’ll never forget from high school years. You see, we have a storied lacrosse program that has won numerous championships. But when I was coming up, it was going through a transition. We weren’t bad, but we played in a highly competitive conference.

My sophomore year, a new coach took over the program. And he wanted to take a different approach. He taught us an important lesson that has stuck with me ever since. He constantly reminded us about the importance of staying humble and not being arrogant. That way, by setting low expectations with our competition, it increased our chances of success in games.

During my 20-plus years on Wall Street, I found the same lesson to be true with investing. The stock market often rallies when investors are least expecting it. Because, typically, the expectation bar for earnings potential is typically too pessimistic. So, when results can hurdle a low bar, investors wind up chasing the rally and pushing the market higher.

Right now, stock-investing sentiment appears pretty negative heading into fourth-quarter earnings reports… that tells me the S&P 500 Index is set up to rally even higher.

But don’t take my word for it, let’s look at what the data’s telling us…

Considering the stock market rallied more than 26% last year, you’d expect investors to be a bit more optimistic about the potential for 2024. After all, one would anticipate individuals and fund managers would have even more money to put to work in risk assets like stocks. Not to mention, those who missed out on last year’s gains would be looking to jump in.

But, according to the Federal Reserve Bank of New York, the household outlook for higher stock prices is at one of the lowest levels in the past decade. The regional central bank’s December Consumer Expectations Survey showed just 37% of the individuals polled expect stocks to rally next year. That matched the high for the year, which was set in July…

But it’s not just households who have a somber outlook. Wall Street strategists are in a similar camp. The median 2024 outlook is for the S&P 500 to end the year at 5,120, or a gain of just 7.3%. That’s one of the lowest expectations in the last 25 years and compares to the index’s annual average of 9.5% on a total return basis (dividends reinvested). According to SentimenTrader, the years with the lowest expectations typically gain 12.1% while those with highest experience just a 2% rally.

But a lot of this may be driven by Wall Street analysts…

Coming into the quarterly reports, they’ve been cutting earnings estimates. According to financial-data provider FactSet, brokerage firms have lowered numbers by 6.8% between the end of September and start of December. That’s much wider than the typical 3.5% reduction over the last five years. In fact, the reduced expectations also exceed the 10-, 15-, and 20-year averages.

The change has brought the S&P 500’s fourth-quarter earnings growth expectation down from 8% to just 1.3%. But there’s a catch… Over the last five years, S&P 500 companies typically report earnings that are 8.4% above analysts’ expectations. Over the last 10 years that earnings outperformance is closer to 6.4%.

So, as I said at the start, both Wall Street and Main Street are pessimistic on the outlook for stocks. In fact, analysts haven’t taken this deep a cut to earnings estimates since the third quarter of 2022. And when those reports were done and dusted, the S&P 500 rallied 6%.

Like my high school coach taught us, low bars are much easier to hurdle. At the end of my junior year in high school, we knocked off the number one team in the country. Early in my senior year, we were the number-two ranked team in our state. And just two years after I graduated, they started a new run of conference championships.

So don’t be surprised if earnings season proves better than Wall Street’s fears. And if it does, look out… because all those pessimists are going to be buying stocks at even higher prices.

Five Stories Moving the Market:

Australia’s monthly inflation gauge moderated for a second straight month in November, rising 4.3% from a year earlier, lower than economists’ estimate of 4.4%, and the smallest annual increase since January 2022 – Bloomberg. (Why you should care – easing inflation will take pressure off the Reserve Bank of Australia to raise interest rates, potentially weighing on global bond yields)

Headline wage growth for Japanese workers slowed sharply in November, an unwelcome development for the Bank of Japan as it seeks evidence of a virtuous cycle linking pay hikes to price increases as a prerequisite for normalizing monetary policy – Bloomberg. (Why you should care – slowing wage growth eases the inflation outlook, diminish the need for the BOJ to raise rates)

Federal Reserve Vice Chair for Supervision Michael Barr suggested the central bank is mulling significant changes to key parts of the pending "Basel III endgame" overhaul for bank capital regulations, a policy that has drawn stiff opposition from the banking industry, which says it needlessly risks causing banks to curtail lending – Reuters. (Why you should care – adopting the proposed Basel changes would soak up the top banks’ $120 billion capital cushion, likely driving up fees for households and businesses)

Hewlett Packard Enterprise struck a roughly $14 billion deal, paying $40 per share in cash, to buy Juniper Networks in a big bet on networking and artificial intelligence – WSJ. (Why you should care – increasing M&A activity is usually a sign companies like the economic growth prospects)

European Central Bank Governing Council Member Francois Villeroy de Galhau said it will cut interest rates this year once it sees evidence the inflation outlook has settled in line with its 2% target – Reuters. (Why you should care – if the ECB lags the Fed in easing monetary policy, it will weigh on the dollar, boosting the outlook for stocks and gold)

Economic Calendar:

Australia – CPI for November

France – Industrial, Manufacturing Production for November (2:45 a.m.)

ECB’s de Guindos Speaks (3:20 a.m.)

MBA Mortgage Applications (7 a.m.)

ECB’s Schnabel Speaks (9 a.m.)

BOE’s Bailey Testifies Before Parliament (9:15 a.m.)

Energy Information Administration Crude Oil Inventory Data (10:30 a.m.)

ECB’s Hernandez de Cos Speaks (2:30 p.m.)

Fed’s Williams Speaks (3:15 p.m.)

Treasury Auctions $37 Billion in 10-Year Notes