(Bloomberg) -- Investors staring down what is forecast to be the biggest drop in corporate earnings since the Covid recession have had no trouble bidding up US stocks.

By one measure, they’ve powered equities to the biggest pre-earnings rally since early 2009, as the S&P 500 jumped almost 6% in the month through Friday even as first-quarter profits are forecast to drop 8%. What gives?

Defensive positioning and relief that banking stress appears contained have helped. But the strength also highlights the enduring faith traders have in Corporate America’s ability to deliver on earnings. First-quarter results won’t be great, but they may beat meek expectations and could mark a low point in the cycle. For a market that relentlessly looks ahead, the bull case is that profit growth will return later this year. 

Such optimism may prove prescient, though skeptics abound. As margins shrink, companies have had more trouble topping estimates. Recent market performance also suggests reason for caution. During earnings season, the S&P 500 has moved in the opposite direction of the prior month in each of the previous four quarters. 

“The biggest risk we really have coming into this season is folks anticipating better-than-low-bar expectations types of reporting, and we’re not really sure that will be true,” Lisa Erickson, head of public markets group at US Bank Wealth Management, said by phone.

Profits from S&P 500 firms are expected to fall to $50.62 a share during the January-March period, analyst estimates compiled by Bloomberg Intelligence show. That would be the biggest profit decline since the 31% slump during the pandemic lockdown.  

Analysts have lowered their expectations heading into the reporting period, which kicks off later this week with Wall Street’s biggest banks. During the last three months, expected income for the period dropped more than 6%, the third straight quarter that cuts have been that deep.

What’s different now is the stock market’s performance. The S&P 500 fell in the month leading up to the last two earnings periods and then bounced back once firms started reporting. This time, the index rallied despite the wave of downgrades. 

Expecting stocks to continue rallying in the coming month means ignoring recent history. Over the past year, when equities rose before the season, they tended to fall once financial results were delivered, and vice versa. 

Meanwhile, the margin by which companies beat estimates is dwindling. For the fourth quarter of 2022, aggregate income came in only 0.3% above estimates, the smallest positive surprise since early 2020.

Going by analyst forecasts, the first quarter likely marked the trough of this earnings downturn. The contraction, which started at the end of 2022, is expected to end in the second half of this year and return to double-digit growth in 2024. 

Trying to gauge what’s priced in the market is far from the exact science. But one way of deciphering how much traders really think companies will earn is to apply a historical multiple to the index and see what pops out on the profit line. By dividing the S&P 500’s current price of 4,110 by a historical P/E of 17.5, the market can be framed as seeing 2023 earnings of about $235 a share this year. That is 7% above the $219 analysts peg them at now.

To Venu Krishna, head of US equity strategy at Barclays Plc, expectations are way too high. He targets $200. 

“Valuations have repriced higher in the hope that we are close to the end of the earnings revisions cycle,” he wrote in a note. “There is still way to go before this rationalization is complete, making this recovery rally premature.”

©2023 Bloomberg L.P.