Earnings estimates are a rigged game – especially in the US

Of all the things that Donald Trump could claim are “rigged” against him, the number of jobs being added in the US economy is one of the oddest. Yes, there are real problems with statistics in many countries, and the situation has got worse since the pandemic. Firing the head of the statistics agency, as Trump did last week, is unlikely to fix that, especially if the replacement is picked for loyalty to him. However, the 258,000 cut to the estimated jobs added in May and June is completely in line with what you’d expect once in a while.

Data like these are prone to big revisions, sometimes long after they are first reported. One difficulty in trying to spot turning points in the economy using trends from past data is that the revised numbers we have now can sometimes be quite different from those reported at the time. Much of the information that statistics agencies collect is important in trying to understand long-term trends. But they are not reliable real-time signals. Investors, like Trump, could afford to take each release a little less seriously.

Earnings estimates are transparently biased

In fact, the prize for the most manipulated statistic in markets surely goes not to a government department, but to the private sector. Earnings estimates – and the ability of companies to beat them – are transparently a rigged game, especially in the US. If analysts’ estimates were an unbiased forecast of earnings, you’d expect companies to beat them 50% of the time and miss 50% of them. This doesn’t happen – on average, companies beat estimates significantly more often.

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The reason is that company management – most blatantly in the US – guide analysts to lower forecasts as the reporting date approaches. They can then report earnings that beat the forecasts, and the positive surprise buoys the share price. However, if you compare reported net income for each quarter to forecasts made further in advance (three months before the quarter), “these ‘surprises’ are somewhat less impressive or not there at all”, says Andrew Lapthorne of Société Générale – see chart above.

Of course, earnings growth matters. Europe or emerging markets look better long-term value than America – but not if S&P 500 earnings keep growing much faster than the rest of the world. If the US continues to excel (which the chart suggests is increasingly a bet on the Magnificent Seven), the S&P 500 might yet come out ahead. But that has little to do with whether companies can beat short-term forecasts that they’ve carefully talked down.

So when the headlines say – as they doing right now – that more than 80% of S&P 500 companies are beating estimates, it is wise to be a bit sceptical. Does this mean that the corporate sector and the US economy is doing even better than expected; or does it suggest that the upheaval as Trump brought in his tariffs in April proved an excellent opportunity to guide down earnings aggressively and ensure a solid surprise?

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