Earnings season is once again upon us and, with the market sporting some concerning valuations, it’s arguably more important than it has been in a long time.
On the one hand, a single quarter’s worth of earnings doesn’t tell you the whole story of the future prospects of a company, but on the other, earnings eventually need to play catch-up to valuations to justify them going forward.
To show you what I mean, here’s a 50-year chart of the Shiller PE ratio from multpl.com.
The Shiller P/E ratio measures the current price of the S&P 500 against the last 10 years of inflation-adjusted earnings.
As you can see in the chart, we’re currently trading at valuations that coincided with the 2021 stock market peak, which were only exceeded by valuations seen at the height of the dot com bubble.
You’ll find similar excesses using the “Buffett Indicator” (market cap to GDP ratio) and the traditional P/E ratio of the S&P.
What does this have to do with earnings?
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Well, there are only two fixes to elevated ratios like these: either prices come down, or earnings go up.
If earnings are healthy (and rising faster than share prices), they can catch up to share prices. If not, stocks are more susceptible to corrections or bear markets as share prices are untethered from fundamentals.
For both the 2021 peak and the dot com bubble, the fix was the latter.
As I mentioned above, one quarter’s worth of earnings doesn’t tell the whole story (especially with the Shiller ratio’s 10-year averages), but it can be useful as a “temperature check” for larger economic trends.
So, with that in mind, I wanted to highlight three earnings hotspots I’m paying close attention to this earnings season to get a gauge on those macro trends. My colleague Chris Preston and I discussed these in more detail in the latest episode of the Cabot Street Check podcast, but here are the brass tacks:
3 Earnings Hotspots I’m Watching Now
1. Consumer Retail
U.S. consumers are the lifeblood of the economy, and when they tighten their purse strings, companies (and by extension their stocks) suffer.
This earnings season, I’m paying closer attention to both Target (TGT) and Walmart (WMT) due to their ubiquity and ability to attract a range of consumers.
Management commentary from these two companies should offer insights into whether the middle class is bargain hunting (which Target’s report on holiday shopping seemed to indicate) or trading down to a lower-end retailer (i.e., Walmart).
Additionally, with Walmart’s earnings coming near the end of February (Feb. 20), management commentary should factor in the impacts of President Trump’s tariff regime and provide more evidence of how higher tariffs are hitting businesses.
2. Luxury Retail
The post-pandemic recovery has been uneven and has hit different segments of the economy at different times.
Lower-income consumers helped carry us through the early days of the pandemic recovery due to stimulus check spending, while higher-income consumer spending (due to high stock market returns and elevated property values) has helped sustain us in the years since.
Even if the recovery has been bifurcated or K-shaped, each segment has contributed to a U.S. economy that has been the envy of the developed world.
For that reason, I’ll be watching LVMH (LVMUY) when they report at the end of January.
Not only will we get a check on or counterweight to the consumer retail measures from the entry above, but we’ll also get more details on spending by high-income consumers globally, as well as a few other consumption trends that we talked about in more detail in the podcast episode (lipstick indicator, alcohol consumption).
3. Insurance
As an industry, insurance has been in the spotlight lately. Between the high-profile assassination of the UnitedHealth Group (UNH) insurance CEO, President Trump promising to “knock out the middleman,” property insurance companies pulling out of uninsurable regions, and Los Angeles wildfires that could cost upwards of $250 billion, we appear to be nearing an inflection point.
Collectively, we could (and probably will) continue to muddle along with higher premiums, lower coverage, self-insurance, state-sponsored property insurers of last resort and the like, but the confluence of events raises the prospect of an industry-wide shakeup.
Add in an incoming president who’s more than happy to go off the beaten path to prove his populist bone fides, and there is, to my mind, no industry as ripe for disruption as insurance. (And that’s not even considering the ramifications of artificial intelligence in an industry that is premised on identifying patterns in large datasets.)
No single earnings conference call will speak to all those items, but if the industry as a whole is feeling the effects of heightened scrutiny (which would probably point to lower profitability) we should hear it in the aggregate.
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