We’re more than halfway through the third-quarter earnings season, and thus far, the S&P 500 overall is reporting its worst year-over-year earnings growth since the third quarter of 2020.1 The percentage of companies in the index posting positive earnings surprises is slightly below its long-term average, while companies’ earnings overall are just 2.2% above estimates—worse than the 10-year average of 6.5%.2
However, a look “under the hood” reveals select areas of real strength and potential opportunity. The chart shows that earnings among value stocks as a group, represented by the S&P 500 Value Index—along with the energy and health care sectors of the index—are giving investors reasons to cheer. For example:
● Value stocks’ 3Q earnings are nearly 6% above estimates.
● Earnings for energy stocks are around 11% higher than expected.
● Health care company stocks’ earnings are close to 10% above estimates.
Other pluses: The magnitude of these positive surprises for all three components of the market has (so far this quarter) exceed what we’ve seen in each of the previous three quarters, and earnings surprises in these sectors are trending up while the market is trending down.
Stock prices are based on expectations, so better-than-anticipated earnings naturally will be rewarded—and indeed, shares of many companies within upward-trending sectors have rallied after their earnings announcements. In stark contrast, third-quarter earnings disappointments from the likes of mega-cap tech companies sent many investors in those stocks running for the exits.
Ultimately, sectors such as energy and health care (which provide the essentials of modern life) exemplify areas of the market that typically benefit from pricing power in inflationary times. Value stocks may enjoy a similar tailwind due to a lower duration of cash flows and generally higher dividends. Conversely, higher interest rates are compressing tech stocks’ multiples while the companies’ earnings are proving to be more cyclical and sensitive to the underlying economic environment than previously thought—prompting some investors to reconsider the sector’s prospects.
The upshot: In this complex environment where market winners and losers can diverge in extreme ways, the case can be made for the benefit of active asset allocation strategies with the flexibility to pursue emerging opportunities.
1 FactSet S&P 500 earnings season update: October 28, 2022
2 FactSet S&P 500 earnings season update: October 28, 2022
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