As the second quarter earnings season gets well underway, major indexes are trading near all-time highs, and are doing so even though revenues and earnings of many corporations are actually shrinking. So far, about a third of the constituents of the S&P 500 have reported earnings; of these roughly 81% have beaten analyst estimates by an average of nearly 6%. Wonderful news for investors -- or is it?
Markets are forward looking mechanisms that reward outperformance, hence the recent new highs. To be fair, since the great recession and financial crisis of 2008, corporations have done a great job at cutting costs, increasing productivity, and (generally) doubling earnings. Moreover, year after year, roughly two-thirds of the companies in the S&P 500 beat analyst earnings forecasts, allowing investors to believe that the companies are thriving and growing.
But that's not the whole story.
Over the past year-and-a-half, earnings and revenues -- in absolute terms -- have barely risen. As a matter of fact, for the current quarterly earnings season, of the companies that have reported second-quarter earnings so far, earnings have shrunk by nearly 1% compared to second-quarter 2015 earnings, and are expected to be down nearly 3% year-over-year. To make matters more concerning, if one eliminates the energy sector -- which has seen a significant and somewhat unexpected earnings rebound -- year-over-year corporate earnings growth is expected to fall by nearly 6%.