After the Federal Reserve’s most aggressive rate hike since 1994, Wall Street was quick to pencil in increased risks of a recession — but analysts left corporate profit estimates largely intact.
Once those estimates are revised downward, some markets observers argue, it could spark further volatility in the ongoing bear market.
Consensus Wall Street analysts shaved down their second-quarter bottom-up earnings per share estimate for the S&P 500 by just 1.1% between March 31 and June 30, according to data from FactSet published Friday. The current estimated year-over-year earnings growth rate for the S&P 500 stands at 4.1% for the second quarter, which if realized, would be the slowest since the fourth quarter of 2020.
The size of that downward revision is much smaller than the reductions seen during typical quarters in recent history: Over the past five years, earnings estimates have been brought down by 2.4%, on average, during a quarter. And over the past 10 and 15 years, these decreases have averaged 3.3% and 4.7%, respectively.
Furthermore, analysts actually raised their earnings estimates for the second half of this year. FactSet noted that the bottom-up earnings per share estimate for the third quarter of 2022 rose by 0.4% between the ends of March and June and was left unchanged for the fourth quarter.
“So far, the ongoing bear market is the first of the millennium to feature rising earnings estimates," Jason Pride, Glenmede’s chief investment officer for private wealth, wrote in a note Tuesday. "In each of the other three, the peak-to-trough decline in the S&P 500 could be attributed to a mix of falling earnings estimates and falling valuation multiples (e.g. price-to-earnings ratios) that are applied to those estimates."
People sit outside the New York Stock Exchange (NYSE) in New York City, U.S., September 15, 2016. REUTERS/Brendan McDermid ·Brendan McDermid / Reuters
The stock selloff of 2022 so far has been driven primarily by valuation pressure as the Federal Reserve has hiked rates and inflation has remained elevated, rather than by a weakening in estimated or actual earnings.
We’ve discussed this issue in the Morning Brief about a month ago. Since then, the outlook for the economy has markedly changed, with firms from Goldman Sachs to Citi calling for a greater likelihood of a near-term recession, purchasing managers’ indices deteriorating, and consumer sentiment sinking as inflation has held up. Crude oil prices have also slid as the recession trade ramped — which may weigh on the profits of energy companies that had seen some of the most marked upward earnings revisions earlier this year.
What hasn’t yet changed has been the consensus outlook on how S&P 500 companies profits will in aggregate be affected by a souring backdrop. And once these estimates begin to reflect those economic concerns, that could make the case for stocks to take another leg lower, Pride argued.
“As the macroeconomic environment becomes more challenging, earnings estimates may face negative revisions,” Pride said. “As a result, the ongoing bear market may have further room to fall as cheapening valuations begin to share the reins with earnings in pushing risk assets lower, justifying an underweight risk posture.”
Pride isn’t the only one to suggest as much. BlackRock strategists in June held calls to buy the dip as the S&P 500 tumbled into a bear market, asserting, in part, that there could be more downside for stocks since investors hadn’t fully appreciated the negative impact inflation would have on corporate profit margins and earnings. Goldman Sachs strategist David Kostin recently argued similarly.
“Consensus profit margin forecasts have further to fall which will likely lead to downward EPS revisions whether or not the economy falls into recession,” Kostin said in a note published Friday. “Assuming no change in expected revenues, the margin compression we model would reduce the median stock’s expected 2023 EPS growth from +10% to 0%.”
Chris Wolfe, chief investment officer at First Republic Private Wealth Management, also sees the case for earnings estimates to be brought in. However, he suggested such a move was perhaps “not overly bearish” for stocks that are already off to their worst start in 52 years.
“I think we need some meaningful downward adjustments in analysts' earnings estimates," Wolfe told Yahoo Finance Live on Friday. “They're just sky high, and it does not comport well with the economic data that seems to be coming out, because we're slowing down. Now, that's not overly bearish, because, remember, prices have already done a lot of the adjusting. We just need some capitulation in analyst and corporate expectations. They're just way too high.”
What to Watch Today
Economic calendar
7:00 a.m. ET: MBA Mortgage Applications, week ended July 1 (0.7% during prior week)
9:45 a.m. ET: S&P Global U.S. Services PMI, June final (51.6 expected, 51.6 during prior month
9:45 a.m. ET: S&P Global U.S. Composite PMI, June final (51.2 expected, 51.6 during prior month)
10:00 a.m. ET: ISM Services Index, June (54.0 expected, 55.9 during prior month)
10:00 a.m. ET: JOLTS job openings, May (10.9 million expected, 11.4 million during prior month)
