Wall Street’s forecasts of corporate earnings are likely to fall, sending the stock market in the same direction.
The numbers show that while analysts have been upbeat regarding profits, sentiment is beginning to shift. Two different ways of looking at the data underscore the recent level of optimism.
First, aggregate 2023 earnings per share forecasts for companies in the
S&P 500
have gained about 1.4% in the past six months, according to FactSet. Sales estimates have risen just under 1%, while estimates for profit margins have increased by a touch as the pressure on companies’ bottom lines from higher pay for staff moderates.
Second, about 58% of all revisions to forecasts for 2023 and 2024 EPS for companies in the S&P 500 have been upward, according to RBC. That is up from less than 40% earlier this year.
Historically, this number has gone as high as roughly 80%, but those peaks usually come right after a recession, when a new economic expansion is starting. 2003, 2019, and 2021 are examples.
But at times when the economy has been growing for a few years and concern about a potential slowdown is mounting, the number tends not to go much higher than 60% or 70%. It often dips below where it is now, which implies cuts to forecasts could account for a greater share of revisions.
Already, early signs are emerging that earnings estimates have peaked. While forecasts for EPS have risen in the past half year, they have declined in the past few weeks. Estimates for aggregate third-quarter EPS for companies in the S&P 500 dropped about 0.4% to $57.85 last week, according to DataTrek Research.
“We expect to see further cuts in the week ahead as analysts set their final Q3 estimates,” wrote Nicholas Colas, DataTrek’s founder, in a recent research note.
A weakening economy as a resut of higher interest rates could bring more cuts. The Federal Reserve may be close to finishing its interest-rate increases because the rate of inflation has been on the decline, but it will keep rates elevated for a while. Higher rates tend to dent the economy with a delay, so more damage to the economy and companies’ sales is likely on the way.
All this is particularly significant because the stock market is already expensive. The S&P 500 is trading at about 18 times the EPS its component companies are expected to produce over the next twelve months, compared with just over 16 times to start the year.
The fact that the ratio has increased even as bond yields have risen, which makes future profits less valuable and should weigh on the amount investors are willing to pay for those earnings, shows that the stock market is optimistic about earnings growth right now.
The corollary is that stocks have a lot of downside if analysts cut EPS estimates. Beware of this market.
Write to Jacob Sonenshine at [email protected]
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