Professional stock market strategists and analysts get paid to offer earnings forecasts. Indeed, earnings and expectations for earnings are what drive stock prices.
History shows that those forecasts almost always start off a little too optimistic.
“Since 1976, the median year-over-year earnings growth forecast in January for the full year ahead is 14%, but expectations on average decline throughout the year to closer to the 5% average EPS growth we have seen over that period,” Morgan Stanley’s Adam Parker wrote in a note to clients today. “Analysts (and company managements) start the year optimistic and then adjust their optimism as the year progresses.”
This is not news.
However, in any given year you might hear from a handful of stock market bears that earnings expectations are too optimistic. While they’re probably right, it’s almost certainly no reason to sell stocks.
Think about it. On average, earnings growth expectations fall throughout the year. Yet, on average, stocks go up throughout the year.
Keep this in mind as we enter a historically unfavorable period for earnings forecast revisions.
“On average, September is the month with the most negative revisions, as if people get back from summer vacation, go to some conferences, and recognise that dialling back their estimates is prudent,” Parker added. “Generally, though, the base case being downwardly revised doesn’t bother the buy- side, which is aware that the consensus estimates in January were too high in 31 out of the last 38 years.”