Modeled Versus Analyst Earnings Forecasts and Future Stock Market Return

Do analysts systematically ignore the connection between future firm earnings and current economic conditions? In their July 2024 paper entitled “Predicting Analysts’ S&P 500 Earnings Forecast Errors and Stock Market Returns Using Macroeconomic Data and Nowcasts”, Steven Sharpe and Antonio Gil de Rubio Cruz examine the quality of bottom-up forecasts of near-term S&P 500 earnings aggregated from analyst forecasts across individual firms. Specifically, they:

• Model expected aggregate S&P 500 quarterly earnings growth as a function of GDP growth, output and wage inflation and change in dollar exchange rate. They also consider a simplified model based only on real GDP growth and change in the dollar exchange rate.
• Calculate the gap between modeled S&P 500 earnings growth and analyst-forecasted growth.
• Estimate how well this forecast gap predicts analyst forecast errors.
• Test the extent to which the forecast gap predicts S&P 500 Index total returns.

Using quarterly actual and forecasted S&P 500 earnings, S&P 500 Index total return and values for the specified economic variables during 1993 through 2023, they find that: (more…)