Investors shouldn't fear diverging from the herd, as earnings season rolls out

This upcoming earnings season is going to be an important one, especially given the rising gap between share price performance and the underlying fundamentals, resulting in extreme market concentration.

For example, the median global stock trades at 15.2 times forward earnings, while it’s at 18.6 times on a non-equal-weighted basis given the heavy U.S. tech weighting, according to financial writer Mike Zachardi. This implies a modest forward real return of 6.6 per cent.

Then there’s the powerhouse S&P 500 to consider. The three-month correlation between the index and the number of stocks advancing has fallen below the dot-com bubble era low, according to Liz Young Thomas, head of investment strategy at SoFi Technologies Inc.

The index itself is up 25.2 per cent from June 2023 to June 2024 and, according to FactSet Research Systems, its constituents are expected to report year-over-year earnings growth of only 8.8 per cent for the second quarter. This is slightly down from the 9.1 per cent earnings growth expectation at the end of March.

The highest growth is expected to come from communication services, health care, infotech and energy, with the weakest results coming from consumer staples, industrials and materials, but this also doesn’t translate directly into share price performance.

More specifically, the share prices of communication services (companies such as Alphabet Inc., Meta Platforms Inc. and Netflix Inc.) and infotech (companies like Microsoft Corp., Nvidia Corp. and Apple Inc.) have gained a whopping 33 and 35 per cent, respectively, over the 12 months ending in June, while their year-over-year earnings growth figures are forecasted to be up around 18.4 per cent and 16.4 per cent, respectively.

The financial services sector (companies such as Berkshire Hathaway Inc., JPMorgan Chase & Co. and Visa Inc.) is expected to have a 4.7 per cent gain in earnings, yet the share price is up 22.8 per cent.

Another standout has been industrials (companies such as General Electric Co., Caterpillar Inc. and Uber Technologies Inc.), which is up 13.5 per cent, yet its earnings are expected to contract 3.4 per cent from June 2023. The materials sector (companies such as Linde PLC, BHP Group Ltd. and Rio Tinto Ltd.) is up 8.4 per cent despite earnings being expected to contract 9.7 per cent.

On the other end, health care (companies such as Eli Lilly and Co., UnitedHealth Group Inc. and Johnson & Johnson) is expected to post a year-over-year earnings gain of 16.8 per cent, but share prices are up only 9.8 per cent. Energy (companies like Exxon Mobil Corp., Chevron Corp. and ConocoPhillips) earnings are expected to grow 12.4 per cent, but share prices are up only 11.4 per cent.

This all means there is an opportunity for those willing to diverge from the herd, including those chasing the tech sector and its large multiple expansion. There are companies in various sectors that are being ignored despite having half-decent fundamentals. You can do this through various means, such as an active manager who specializes in stock selection, or by creating your own index that uses passive sector exchange-traded funds.

For those wondering if it’s worth looking closer to home, there is better breadth up here, as 118 of the 226 companies (52 per cent) on the S&P/TSX composite are beating the index this year compared to only 25 per cent in the United States, according to BNN Bloomberg’s Frances Horodelski.

High interest rates have also hit certain segments quite hard, including the Canadian banks, utilities and telecoms that dominate the composite index, even though we believe rates will be coming down faster here than in the U.S.

We would look to reduced debt-servicing costs as a large benefit to their earnings, but the big question remains if the Bank of Canada cuts as much as they should or follows the slower pace of the U.S. Federal Reserve.

Overall, one thing is for certain: now is a great time to deploy the use of good old-fashioned portfolio management, looking at tactical asset allocation to add value while minimizing the risk. At a minimum, consider the merits of rebalancing as companies roll out their earnings in an environment where expectations are quite robust in certain segments and less so in others.