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This is an impressive result given the challenges currently facing companies\u2014intense cost pressures, COVID-19, and Russia\u2019s Ukraine invasion with resulting sanctions.<\/p>\n
The revenue growth corporate America was able to generate\u2014over 13% year over year\u2014was perhaps even more impressive. An upside surprise of about 2.7 percentage points doesn\u2019t sound like a lot, but for revenue it is. Revenue is easier to predict, and companies can\u2019t cost cut their way to more sales. The five-year average is 1.7 points of revenue upside, and the pre-pandemic average was 0.8.<\/p>\n
Here are some more numbers to put these impressive results in perspective:<\/p>\n
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- A very strong 78% of S&P 500 companies beat earnings estimates for the quarter, slightly above the long-term average of 77%.<\/li>\n
- Excluding financials, S&P 500 earnings per share are on track to grow about 14%.<\/li>\n
- Excluding energy, S&P 500 earnings per share are on track to grow only about 4%.<\/li>\n
- The biggest upside earnings surprises came from utilities, while consumer staples, financials, healthcare, and materials also generated strong upside surprises.<\/li>\n
- Consumer discretionary was the only sector to miss analysts\u2019 earnings target, falling a massive 35% short due to Amazon. The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) remains underweight to the consumer discretionary sector.<\/li>\n
- A solid 74% of S&P 500 companies have beaten revenue forecasts, above the five-year average of 69%.<\/li>\n
- About half of the revenue growth for the quarter came from the energy and healthcare sectors.<\/li>\n
- The biggest upside revenue surprises came from energy and utilities, while only communication services missed analysts\u2019 revenue target.<\/li>\n<\/ul>\n
Biggest Challenge: Profit Margins<\/b><\/h3>\n
In our earnings season preview on April 18, we highlighted three things to watch: margin pressures, pricing power, and supply chain status. Clearly two of those three things relate to profit margins, though we would argue all three do.<\/p>\n
In this inflationary environment, the revenue is coming through. But it is profit margins that were the biggest test for corporate America this quarter, and companies passed that test with flying colors. Not only did margins hold up well quarter over quarter\u2014falling less than anticipated\u2014but analysts\u2019 estimates for margins going forward still show margin expansion from current levels\u00a0[Figure 2]<\/b>. We know analysts\u2019 estimates tend to be overly optimistic, but we still view the trajectory of these forecasts as a positive sign for future profitability.<\/p>\n
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<\/figcaption><\/figure>\n However, these margin forecasts will be tough to reach in the coming year if high inflation lingers. Although signs of a peak in inflation have emerged, the pace of improvement may be stubbornly slow. It\u2019s difficult to envision the labor market getting significantly better in a short period of time, but labor market participation is key to alleviating wage pressures and wages are the biggest component of companies\u2019 cost structures. And company guidance suggests supply chain disruptions may linger well into the fall, longer than we previously anticipated.<\/p>\n
Estimates Keep Going Higher<\/b><\/h3>\n
Inflation is not a new challenge for companies. The Consumer Price Index has increased more than 6% year over year for seven months now. Last fall, before Russia\u2019s Ukraine invasion, in\u00a0Outlook 2022: Passing the Baton<\/i>, we wrote the following:<\/p>\n
With stable profit margins and increasing share buybacks likely next year, a double-digit percentage increase in S&P 500 earnings per share (EPS) is a possibility. But COVID-19-related supply chain issues and materials and labor shortages are risks that could lead to higher costs in 2022, weighing on profit margins.<\/p>\n
That led us to our conservative forecast for S&P 500 EPS in 2022 of $220, only 6% above the now-final EPS number for 2021. But instead of seeing estimates come down because of these cost pressures, they have continued to move higher. The consensus estimate for S&P 500 EPS in 2022 has increased 2.6% this year to $229.22 per share, which is remarkable considering how difficult the operating environment has become\u00a0[Figure 3]<\/b>.<\/p>\n
![](\"https:\/\/www.lpl.com\/content\/dam\/lpl-www\/images\/newsroom\/read\/wmc\/lp_WMC_5162022_3.png\")
<\/figcaption><\/figure>\n How have they done it? Primarily through pricing power that has boosted revenue. The consensus estimate for revenue this year has increased 4.2% year to date. It hasn\u2019t been difficult to sell customers on the idea of paying higher prices in this environment when higher costs are affecting everyone. The good news is higher wages and pandemic savings have helped consumers afford those prices.<\/p>\n
Companies have also managed higher costs efficiently, in many cases doing more with less. That narrative certainly fits the energy sector which is also enjoying a revenue windfall. Energy sector employment has fallen significantly over the past couple of years, according to Bureau of Labor Statistics data. National employment is still below pre-pandemic levels, yet trailing 12 month S&P 500 revenue is up 12%.<\/p>\n
Bottom line, we recognize our $220 per share forecast for 2022 S&P 500 earnings is probably too low and that number probably comes in closer to $225, up 8% year over year.<\/p>\n
Can Earnings Help This Market Turn Around?<\/b><\/h3>\n
Earnings will be part of the stock market rebound we expect over the rest of the year. We expect S&P 500 earnings to grow high single digits this year despite the aforementioned challenges. Those gains, coupled with much more reasonable valuations following the selloff, may help push stocks higher in the coming months.<\/p>\n
However, inflation is the most important piece of the story. Until markets get confidence that inflation will move steadily lower over time and become comfortable with the role the Federal Reserve will play to get us there, P\/E multiple expansion will be tough to come by and stocks may remain in correction territory. On the other side, keep in mind just two additional points on the P\/E\u2014from 16.5 to 18.5\u2014would push the S&P 500 12% higher.<\/p>\n
We continue to prefer a modest overweight allocation to equities and a slight underweight to fixed income relative to investors\u2019 targets, as appropriate. Our year-end 2022 fair value target for the S&P 500 is 4,800\u20134,900, 19% above the May 13 closing price at the low end. We are actively considering adding to our equities allocation.<\/p>\n