Corporate Earnings Forecasts and the Stock Market

Wall Street's projections for corporate earnings are expected to decline, which may have a significant impact on the stock market. Recent trends indicate a shift in sentiment among analysts, who were previously optimistic about profits. Let's delve into the data to understand the extent of this change.

Positive Trends in Earnings Estimates

FactSet's analysis reveals that aggregate earnings per share forecasts for S&P 500 companies for the year 2023 have increased by approximately 1.4% over the past six months. Similarly, sales estimates have seen a modest rise of just under 1%. Additionally, profit margin estimates have slightly improved, as the impact of increased wages on companies' bottom lines becomes more manageable.

Upward Revisions in Forecasts

According to RBC, around 58% of all revisions made to earnings per share forecasts for the years 2023 and 2024 have been upward. This marks a significant increase compared to earlier this year when such revisions accounted for less than 40% of the total. However, it is worth noting that such high percentages of upward revisions typically occur post-recession, signaling the beginning of a new economic expansion. Examples include the years 2003, 2019, and 2021.

Setting Realistic Expectations

During periods of prolonged economic growth with mounting concerns of a potential slowdown, the percentage of upward revisions tends to hover around 60% to 70%. In fact, it often dips below the current level, implying the likelihood of forecast cuts becoming a larger portion of revisions.

These developments in corporate earnings forecasts hold substantial implications for the stock market. Analysts and investors should remain alert as these numbers continue to evolve.

Earnings Estimates Indicate Potential Trouble Ahead

Already, there are signs that earnings estimates may have hit their peak. While EPS forecasts have been on the rise over the past six months, they have recently started to decline. According to DataTrek Research, aggregate third-quarter EPS estimates for companies in the S&P 500 dropped by about 0.4% to $57.85 last week.

In a recent research note, Nicholas Colas, the founder of DataTrek, expresses his anticipation of further reductions in the coming week as analysts finalize their Q3 estimates.

The potential for a weakening economy due to higher interest rates could result in even more cuts. Although the Federal Reserve may be nearing the end of its interest rate increases due to a decline in inflation, rates will likely remain elevated for a period of time. It is worth noting that higher rates often negatively impact the economy and subsequently affect companies' sales.

This situation becomes all the more significant given that the stock market is already deemed expensive. Currently, the S&P 500 is trading at approximately 18 times the expected EPS of its constituent companies over the next twelve months. At the start of the year, this ratio was just over 16 times.

The fact that this ratio has increased despite rising bond yields, which reduce the future value of profits and should consequently lower investors' willingness to pay for them, indicates a strong optimism surrounding earnings growth in the stock market.

It is crucial to recognize that if analysts further reduce EPS estimates, stocks may face significant downside risks. Caution is advised when navigating this market.