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Look at Wall Street forecasts, and the pandemic increasingly seems like little more than a lost year. Predictions for S&P 500 earnings per share this year are almost back up to where they stood at the start of March 2020, before the reality of Covid-19 put red lines through everyone’s outlook.

As the earnings season gets under way, two things stand out: just how much the earnings improvement has mattered this year and just how little disappointing earnings have mattered in the past few years.

Start with this year. Operating earnings for 2021 are expected to come in 14% higher than analysts were forecasting at the start of January, and the S&P is up 16%. Higher 2021 profits seem to explain higher stock prices almost perfectly.

Yet look back further and the explanation collapses. Earnings are still predicted to be lower this year than they were forecast to be in February 2019, when Refinitiv began collecting the Wall Street average for 2021. If the market moved purely with annual earnings predictions, stocks would be about a 10th lower than they were then, but in fact the S&P is 60% higher.

Why do earnings matter this year when investors paid so little attention to them in the past? The answer has three parts.

The first is that forecasting earnings two years out is little better than guesswork, and everyone knows it. Each year since 2013, the starting Wall Street average predictions collected by Refintiv were 11% to 12% higher two years ahead than one year ahead, no matter what the economic, political or financial situation. When the forecasts began to be collected for 2023 in February just gone, they were again 11% higher than the 2022 prediction at the time. So back in 2019 those 2021 predictions had little credibility.

The second is that the effects of the pandemic are still with us. Investors rightly concluded that last year’s crash in earnings was temporary, and stocks recovered even as 2020 earnings continued to be marked down. This year many companies will be impeded by supply-chain disruption, difficulty in hiring and higher raw-material and wage costs. Investors are assuming that the impact of these issues on inflation is temporary; if they are right, then the same goes for the effect on earnings, meaning there is scope for further profit recovery as disruption fades.

Finally, this year is quite different from the previous couple of years because investors have been focused on the prospects for cheap, or value, stocks. The profits of companies beaten up by lockdown, such as banks and airlines, have rebounded, making their shares more attractive. But investors don’t think their long-term prospects are any better than before the pandemic. They still aren’t priced to deliver growth, and their valuations are slightly down, measured as price to 12-month-forward earnings.

Before this year the investor focus was on growth stocks, which meant that in both 2019 and 2020 rising valuations were the main driver of prices, not earnings. Valuations jumped as enthusiastic investors priced in big growth far into the future, helped by lower bond yields making far-distant profits even more valuable.

That couldn’t last, and the combination of the near-term recovery and higher bond yields, at least earlier in the year, helped value beat growth.

The earnings season might give us some clues about all three elements. 

First, we should be able to think more clearly about profits next year with more evidence about how things have progressed. Second, CEOs are likely to give us clues about just how temporary they think the post-pandemic disruption will be. (My guess: It will last longer than the Federal Reserve thinks but still be temporary.) 

Finally, CEOs of cheap companies reporting fatter profits will surely try to convince us that they have rebooted their prospects, and so deserve a higher valuation; some growth companies that benefited from stay-at-home spending will struggle to show they are on a path to permanent expansion and might deserve a lower multiple.

One thing that won’t change: In a market dominated by companies with prospects far in the future, bond yields are still likely to matter more for investors than quarterly profits reports.

Write to James Mackintosh at james.mackintosh@wsj.com

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