It’s showtime baby! As many of y’all are aware, Q4 earnings season tends to be a bit longer than the others, as it takes a little while longer for companies to close the books on their year-end. We expect earnings to take the center stage going forward, where reactions to earnings have been getting bigger, while reactions to inflation/FOMC have been waning (Chart below). As many of y’all know, this is one of our core themes moving forward: “Inflation to Growth Frustration”.
With a focus on the Fed tightening cycle, peaking inflation, and a 2023 recession, S&P 500 earnings have declined to reflect the economic pain ahead. Yet, economists and analysts are unsure how far earnings will fall. Next year’s EPS is down -9% since the June ’22 peak to $228, over 2x the typical cut over the same period. The bar could be lowered dramatically as management teams have the cover to lower guidance. With growth still estimated to be about 4% next year, the consensus remains a ways off from accounting for a recession. We’ve said it before: the median decline in earnings during a recession is 20%.
Looking at the full-year 2023 sales estimates shows that expectations are being reset lower on both the top and bottom line. Sales growth for the year is now expected to be 2.5%. What’s important is that this growth rate is expected during a period where inflation is stickier, and companies are charging more. It will be imperative over the next several quarters to also watch unit sales on top of dollar value of sales as higher prices may mask underlying weakness in businesses.
Our Biggest Worry: We expect tighter monetary conditions to exist for some time. This is likely to have a continued and negative impact on companies’ ability to expand operating margins. While the “money illusion” can result in higher levels of nominal earnings and make recession-related percentage earnings declines appear less severe than they would in low inflation regimes, contracting operating leverage in combination with tighter financial conditions has historically led to lower earnings and earnings growth.
Sell-side stock analysts are forecasting an increase in operating earnings this year of +3.5% on the heels of an increase in revenues of only 2.5% – an implicit expectation that S&P 500 corporations will be able to expand profit margins this year – seems unlikely to us. Simply said, the Street’s estimates still imply profit growth for CY’23. This is inconsistent with the near universally held view that the U.S. economy will contract in the next year.
Fun Fact: The biggest differences between sector market cap weights and their respective earnings weights are in the Energy and Technology sectors. The Energy sector represents 12.4% of the Index’s earnings but makes up only 5.2% of its market cap. The Technology sector, alternatively, represents 21.4% of the Index’s earnings but 26.3% of its market capitalization.
As always, I’ll do a recap of the earnings season in a few weeks, of which, I expect there to be a lot of fun intertwined between now and then.
Please reach out to us if you have any thoughts / questions / comments on the individual reports. We have our ear to the ground and would love to filibuster a conversation on any stock talk.
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