We have all been invited to a function or party we just didn’t look forward to, only to be surprised with a very pleasant event. Before you knew it, you were socialising like a pro, and by the time midnight struck, you were the one proudly showing off your best dance moves.
Your initial pessimism was replaced by bubbling positivity.
At the beginning of 2019, investors were very sceptical of stock reviews for the year to come, especially with the S&P 500 index having lost 14% of its value between the end of September 2018 and 31 December 2018. But the party quickly started, with the same index now trading 23% higher in US-dollar terms (as at 28 October 2019) for 2019 so far.
The fact is, forecasts for this year definitely weren’t as positive as the actual market performance to date.
Shares have a tendency to react very positively following better-than-expected results (earnings growth), but also to react negatively when reported results are worse than expected. In times of great negativity, it may influence investor sentiment to such an extent, that it can cause a total collapse, which is what happened in 2008.
It doesn’t matter if companies’ results are better compared the prior reporting period. If this doesn’t meet expectations, it can still cause the share price to drop dramatically, just because the party wasn’t exactly what investors expected.
It is clear, therefore, that consensus forecasts are being watched very closely, and that this plays a major role in short-term market volatility.
I often mention that experts are by no means fortune tellers. While, undoubtedly, there are analysts whose forecasts are incredibly accurate, there will always be a few who miss the mark by a mile. Some of the reasons why analysts end up making erroneous forecasts include:
1. The fact that it is incredibly difficult to make earnings forecasts. There are so many variables to consider that they can’t even count on expecting the unexpected.
2. Analysts’ forecasts have a tendency to move closer together as time passes. The problem with this is that the proverbial herd isn’t always right.
4. The art of softening the blow when it comes to bad news is one that many companies have mastered through well-planned press conferences and other types of meetings.
If we take a look at things as they are now, roughly 70% of the S&P 500 companies (or 339 companies) have already reported as at 31 October 2019. So far, 75% of these companies’ earnings have comfortably exceeded Thomson Reuters consensus forecasts, while 59% surpassed turnover forecasts. Usually, along with expectations of a decline in global economic growth, analyst forecasts will lean more towards the conservative side, but this is not quite the case at present.
According to the same Thomson Reuters consensus forecasts, analysts expect the party to continue with 9% growth (excluding dividends) predicted for the next 12 months for the S&P 500 Index. If they happen to be 100% correct, that should place the price-to-earnings ratio at 21.7 times, which cannot necessarily be considered as cheap.
What I’m saying is that you shouldn’t miss out on a party just because you’re afraid that you may not enjoy it. Surprises currently tend to be on the positive side and, although it’s not bargain time just yet, you should caution against aggressive selling.
S&P500 Index expected 12-month growth
Source: PSG Wealth Old Oak & Thomson Reuters
Schalk Louw is a portfolio manager at PSG Wealth.