In the world of finance, particularly within the context of China's A-share market, the relationship between earnings forecasts and stock market performance unveils a complex narrativeContrary to common belief, a downward revision in earnings forecasts does not invariably lead to a corresponding decline in stock indicesIn fact, should valuations already be at lower levels, such a revision might even trigger an upward movement in stock prices.

Recent observations reveal that the A-share market has experienced an upswing, with the Wind All A-Share Index (Wind All A) recording an impressive increase of over 13%. Analysts speculate that the low point observed at the end of April may represent a significant bottom over a three to four-year cycleNevertheless, a degree of apprehension lingers among investors who worry that economic downturns could lead to further adjustments in corporate earnings, exerting pressure on the overall market.

Historically, the correlation between downward revisions of earnings forecasts and market trends has proven to be weak

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Instead, market performance in times of substantial forecast reductions is often more influenced by prevailing valuation levelsEmpirical analyses suggest that A-share earnings forecasts tend to be adjusted downwards throughout the yearIt is also noteworthy that the relationship between these revisions and market movements is far from straightforwardTypically, significant downgrades in earnings forecasts coincide with periods of economic contraction, as was the case during the first half of 2012, the second half of 2015, and throughout 2018, 2019, and the early part of 2020 amid the pandemicDespite these downgrades, the annual performance of A-shares in those years varied significantly, with markets experiencing increases in 2012, 2015, 2019, and 2020, while 2016 and 2018 saw downswings.

A discernible pattern emerges from the analysis of historical data: in years where substantial earnings downgrades occur, if the valuations at the end of the preceding year were already at historically low levels, the market could still experience gains

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Conversely, if the prior year’s valuations were high, the likelihood of a market decline increases following a downgradeThis variance highlights the pivotal role of valuation relative to earnings forecasts in shaping market responses.

Examining sector-specific earnings forecasts reveals a similar trend, where the correlation between industry earnings revisions and subsequent industry performance appears weak as wellLike the broader A-share market, valuation remains a critical determinantInstances have been observed where industry forecasts may be notably downgraded, yet if those sectors were already regarded as undervalued, the industry indices could still surge.

Reflecting on the recent pandemic, it seems that the current round of earnings forecast reductions in A-shares may be less severe compared to those during the peak of the COVID-19 outbreak in 2020. In the wake of that crisis, the complete set of A-shares noted drastic revisions in net profit expectations, particularly concentrated around the release periods of annual and quarterly reports

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Notably, between January and May 2022, the total revised net profit for all A-shares saw a 6.7% adjustment downwards, surpassing the historical average decrease of 3.5%, with the year-on-year growth rate dropping from 30.9% early in the year to 22.2%. In comparison, during the same timeframe in 2020, net profit projections were revised down by 10.4%.

Future expectations for earnings may continue to face downward adjustments; however, the extent could be limitedThis outlook is primarily informed by the comparative analysis of economic growth rates during the 2020 and 2022 crisesFor instance, in 2020, amid the pandemic, industrial output values experienced a dramatic decline from a year-on-year growth of 6.9% in December 2019 to a staggering -25.9% in February 2020. In contrast, the data for 2022 revealed a more moderate dip, falling from 12.8% in February to -2.9% in April, with preliminary data in May indicating a slight recovery

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Such variations suggest that while the pandemic imposed significant economic challenges, the most severe repercussions could be receding.

Moreover, considering the GDP trajectories, the actual growth in GDP plummeted from 6.0% in 2019 to just 2.2% in 2020. For 2022, governmental reports propose a target growth rate around 5.5%, with the actual growth likely to fall short of this target due to the pandemic’s effects, yet not deviate drastically compared to the previous year's decline of 8.1%. This analysis indicates that the reduction in A-share earnings for 2022 may be comparatively milder, though ongoing observation of stabilization policies will be critical in evaluating future trends.

In summary, the convergence of valuation levels and earnings forecast adjustments presents a compelling narrative regarding market behavior

When the market valuation is already at a low point during downward revisions of earnings forecasts, projected market declines may be minimal or even reversed into gainsAs of April 26, 2022, following notable declines in the early months of the year, A-share valuations have retraced to historically low standards, with a total PE ratio of 15.2 times, considerably below the mean of 21.6 times seen since 2005. This positions the market within a lower percentile bracket historically, implying that the potential pressure from earnings forecast downgrades may be limited moving forward.

Additionally, several sectors, particularly consumer and manufacturing industries, have witnessed significant downward revisions in profit expectations while simultaneously maintaining low valuation standardsAnalysis indicates that within such low valuation contexts, even substantial earnings downgrades may not necessarily drive industry indices lower