Earnings Season Is Coming. Get Used to Disappointment.

Earnings season is about to begin—and investors might want to consider a cautious approach.

It’s not that profits won’t grow. S&P 500 earnings per share are expected to grow 24% year-over-year, according to FactSet data, boosted by a wipeout from the pandemic in March 2020. The rapid recovery will be a particular benefit for manufacturers, retailers and restaurant operators because expenses in those industries are heavily comprised of fixed costs, and more sales lead to greater products without expenses rising too much.

Overall sales are expected to grow by just 6% but the market could have trouble meeting that number. That’s because of supply shortages, which could make it impossible for some companies to meet demand. That could lead to “missed sales altogether,” writes Mike Wilson, Morgan Stanley’s chief U.S. equity strategist. Importantly, part of the shortage has resulted from exploding economic demand.

Margins—while expanding compared to last year—could also disappoint relative to expectations. The price of oil is almost three times higher than it was last year, while copper is up almost twofold. Even corn is up 67% year-over-year. Companies, from manufacturers to consumer firms, are experiencing higher input costs. The prices paid component of the Institute for Supply Chain Management’s manufacturing data recently hit its highest level in over a decade. With producer prices recently rising faster than consumer prices, margins are bound to suffer, Wilson said.

Meanwhile, earnings expectations are already lofty, creating a high bar for companies to clear. Analyst estimates for the S&P 500 in aggregate have increased by almost 9% during the past six months, according to FactSet. “That’s really fast,” said Brandon Pizzurro, portfolio manager at GuideStone Capital Management. “That definitely feels dizzying.”

Earnings misses would be particularly painful for stocks, which are pricing in the high profit projections. The average S&P stock trades at over 22 times next year’s earnings, but rising interest rates make stocks less attractive andmany strategists are using a 20 multiplefor their S&P forecasts.

The upshot: Be careful during earnings season.