Solid Earnings Aren't Saving The Market

First-quarter results have been generally positive, but that has been little comfort for investors this earning season.

By the end of last week, earnings per share for the S&P 500 were on track for 11% year-over-year growth, on a 13.5% increase in revenue, per data from Credit Suisse. Yet the index has dropped more than 10% since the results started coming in early last month. The Nasdaq Composite has shed almost 20% in a month. What gives?

Simply put, investors have been more focused on the macro than the micro this earnings season.

And that all comes back to the Federal Reserve and tightening monetary policy. A handful of other wild cards just introduce more uncertainty and volatility, including the war in Ukraine and all its tragic implications. Those have been a recipe for lower stock and bond prices, which move inversely to yields.

Overall, stock valuation multiples have declined faster than earnings have grown. The macro pressure has been especially strong on growth-oriented areas of the market—where the micro often hasn’t been particularly helpful either. The Vanguard S&P 500 Value exchange-traded fund has lost about 7% since the start of first-quarter earnings season, versus an 18% drop for the Vanguard S&P 500 Growth ETF.

Companies that are projected to earn the bulk of their profits far out in the future are worth less today when those earnings are discounted back to the present using a higher interest rate.

Cash is effectively worth more today, favoring more mature, profit-generating businesses versus the startups and more early stage growth companies out there. That is why the shifting monetary policy environment has hit valuations of growth stocks the hardest, particularly in sectors like technology, software, consumer discretionary, and biotech.

First-quarter revenue and earnings growth, meanwhile, has been strongest in the energy, materials, and industrials sectors of the S&P 500.

S&P 500 value stocks have reported year-over-year earnings and revenue growth of 14.0% and 13.7%, respectively, versus 9.3% and 13.1% for growth, according to Credit Suisse.

Faster profit and sales growth from cheaper value stocks than highly-valued growth stocks? Not what investors have gotten used to.

Overall, S&P 500 value stocks trade for about 15 times their expected earnings over the coming 12 months. That is down from just over 17 times in early 2022. S&P 500 growth stocks, meanwhile, have seen their forward price-to-earnings ratio drop to below 21 times, from about 28 times, since the start of the year. That multiple has slid to 17 times, from about 21.5 times, for the S&P 500 as a whole.

Pair the Fed tightening with high-profile disappointments from growth stocks, and you have a declining market despite solid earnings headlines.