Recent earnings estimate increases have given confidence that any pullbacks in this extremely overbought market should be viewed as buying opportunities. Higher odds of an interest rate cut by the Federal Reserve this year are helping justify stock valuations. However, caution is advised as the S&P 500 Short Range Oscillator is overbought, which historically has led to a pullback. Selling to raise cash and trimming of certain stocks are measures being taken in preparation for a potential decline. It is important to analyze where earnings revisions are coming from and going to in order to determine the depth of a possible decline once the current momentum dies down.
Looking at earnings estimates for the different S&P 500 sectors, it is observed that three out of the top five weighted sectors saw their 2024 earnings estimates revised higher, while five of the bottom six sectors saw downward revisions. Since the end of the first quarter, four of the top five sectors have seen upward earnings revisions, including the financial sector. Meanwhile, four of the bottom six sectors also saw earnings estimates revised higher. This broadening trend indicates a better outlook for U.S. corporate earnings compared to 45 days ago, supported by recent cooler inflation reports.
Valuation dynamics are an important factor to consider as underlying earnings estimate revisions have a greater impact on near-term price action than stock price-to-earnings valuations. A market supported by fundamental factors such as upward earnings estimate revisions is likely to experience shallow pullbacks that should be viewed as buying opportunities. On the other hand, if stock prices are moving higher while estimates are being revised lower or unchanged, caution is advised as the move may be based on momentum and multiple expansion, which is not sustainable.
The upward earnings estimate revisions reflect an improved outlook for corporate earnings, which is the primary financial metric used to value equities. Stock price appreciation appears to be supported by these fundamentals, indicating that any pullbacks in the overbought market should not be concerning and should be viewed as chances to buy. While the timing of a Fed rate cut remains uncertain, the expectation is more towards easing rather than tightening, which supports multiples and the view that earnings will grow into the valuations. Overall, the market is showing signs of strength and resilience, with a focus on fundamentals and earnings driving stock price movements.
