🏒 A hockey stick chart

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Friends, I need to show you a hockey stick chart.

For the unfamiliar, it’s not some complicated technical pattern that you have to stand on your head and squint to understand.

It’s literally a chart that looks like a hockey stick. (I know, so very unlike Wall Street to just say the obvious thing.)

But what’s eye-catching about hockey stick charts is that the trend is flat, then linear, then explosive. The kind of growth you want to see if you’re a cup-half-full, bright-eyed optimist.

Here’s the chart.

Seems like a stock you’d want to buy, right?

Well…this isn’t just one stock. It’s actually profit growth projections for the S&P 500, an index of the biggest companies in America.

Not only that, but S&P 500 profits are expected to grow 23% this year, with earnings estimated to increase in every single sector. Profit growth this strong and broad hasn’t happened since 2018 – the year after the Tax Cuts and Jobs Act was signed into law.

In a world of murky and confusing economic and policy trends, it’s nice to see a hockey stick chart for something that touches so many aspects of our lives and portfolios.

But before you back up the truck to dump a fresh new slug of cash into the stock market, consider that two things can be true:

Corporate America is absolutely killing it, and

Stories can manifest differently in your portfolio versus on paper.

Great trends don’t always lead to great trades.

First, we need to understand what we’re looking at.

Earnings estimates are rising because the economy is unexpectedly accelerating. This is obviously a good story, and you can see it all over the sector breakdown.

Energy company profits (which are notoriously volatile) are expected to rise 71% this year. 

Earnings of tech companies – semiconductor, software and hardware names – could increase 52%. Makes sense if you’ve kept up with the insane earnings reports the hyperscalers and chipmakers have been flaunting this year.

Industrials and materials aren’t far behind, enjoying a lift in earnings from AI application and data-center construction.

Real estate and health care, on the other hand, are picking up the rear with single-digit growth.

When you consider market weights, tech accounts for more than half of the expected 23% in growth. 

The gap between the biggest and smallest earnings  growers is historically wide, in a divergent economy supporting a stock rally with glaring pockets of haves and have nots. The concentration in the stock market is happening in earnings as well.

This dynamic requires you to be smart about where you’re putting your money, especially now that the AI trade has moved beyond the biggest and most profitable players. Sorry to the hyperscalers, who just notched their worst month in 18 years.

I’m not totally writing this hockey stick chart off because of AI, but I am side-eyeing it a little. 

Also, soaring expectations can be more validation than signal.

This earnings outlook is obviously a good proof point for stocks near record highs. 

It may not be the right recipe for a gangbusters rally, though.

The stock market performs best in a low-expectations, mid-to-high results environment. The two best years for the stock market in the past decade and a half (2013 and 2019) materialized around lukewarm years for profits, mainly because expectations were subdued. Two years ago, the S&P 500 clocked a 24% year when profits barely grew.

Today, there are high expectations and TBD results.

Like 2018 and 2011, when earnings growth was great (but expected to be great). The S&P 500 fell 6.2% and went nowhere in those years, respectively.

Why does this happen?

Because profit optimism tends to follow prices.

Not the other way around, as some may lead you to believe.

Stocks aren’t trading on what’s happening today, but what could happen a year or more into the future. 

When the world feels broken and economic conditions seemingly can’t get much worse, the stock market is often the first indicator to rise from the ashes.

On the other hand, it’s also the first sign of trouble before a crisis – usually when you’re on top of the world and convinced nothing can go wrong.

Earnings estimates aren’t particularly prescient in this way. In the 10 longest earnings droughts since 1990 – when S&P 500 profit projections fell from a 52-week high – prices fell in six out of 10 instances before estimates did.

What that can lead to is over-optimism – high estimates that generate a lot of buzz, but ultimately don’t pan out.

Not necessarily because Wall Street experts are recklessly euphoric, either. Instead, earnings estimates are just that…estimates. Educated guesses. Never guarantees, because you never know if there’s a pandemic, or war, or (insert rare catastrophic event here).

Bottom line: earnings expectations should make you hopeful for the future. It is a hockey stick chart, after all.

How could you – as a shareholder with a claim on aforementioned company profits – not be excited about an explosion in company profits?

But I also want you to see this hockey stick chart through the clearest lens, because one thing we don’t do is move about the world blind to risk. 

Earnings create a strong foundation for stock prices. A center of gravity to hold onto if things go awry. 

There are a lot of pieces to this story, though. And many of them could already be baked into this incredible market rally we’ve enjoyed up until now.

Skate where the puck is heading, not where it’s already been.

Thanks for reading!

Callie