To The Moon

Bears maintain that the S&P 500’s winning year is on borrowed time. I hear more and more about an upcoming “earnings recession” where companies are expected to report notably poor earnings in upcoming quarters.

Investors pay for earnings. They buy stocks to secure earnings, to be entitled to those earnings. An earnings recession would mean falling stock prices and a market rout.

But there’s a good chance we’re not going to get worst case scenario.

Sometimes the stock market prices in bad news as it happens. But sometimes there is so much anticipation for something that the market prices it in beforehand. If I told you that equities would have negative returns in 2024, you would probably move your portfolio out of equities on December 31, 2023.

That’s what I think has happened with the earnings recession. There has been so much discussion of it, many portfolio managers and investors have already adjusted for disappointing earnings. The trade down has at least partially occurred in anticipation of poor earnings.

An earnings recession could be priced in. In that event, the stock market won’t have a large negative reaction if it actually happens. If it doesn’t happen, stocks will have to correct upward.

I’m not trying to say that the earnings recession is fully priced in. There are investors who are bearish and those who are bullish, and many bulls reject the thesis and have taken the opportunity to buy/hold. However, the earnings recession is so widely discussed and believed that I find it likely to be mostly priced in.

Let’s talk about the data.

I’ve noticed in many stocks that the forward P/E ratios are lower than their trailing P/E. Investors care about how much a company will make when they buy shares of it, not how much it has made. And investors are now paying less for future earnings.

This indicates people aren’t willing to pay for declining earnings. It also could show that investors expect many companies to miss earnings expectations.

Either way, earnings are already projected to fall. The price for those earnings, current stock prices, is low. Stocks already have low prices to reflect low earnings. I do not expect a bear market to emerge out of any potential earnings recession, unless it comprises of unanticipated huge earnings misses.

If anything, stocks don’t look expensive to me right now. I’m not hurrying to buy them, because they look cheap given the circumstances. People are trading stocks down because there is so much bad potential news and economic uncertainty.

Fixed income instruments are getting more popular, and T-bills don’t have bad yields. This makes investment grade bonds more attractive than they’ve been in a long time. Investors are fine sitting out of stocks for a while and exploring their options. That being said, I don’t think stocks are in for an absolute beating. I’ll keep my hat in the ring.