Wall Street analysts’ optimistic forecasts for corporate earnings are expected to decline, indicating a potential downturn in the stock market. While analysts have been positive about profits, recent data suggests a shift in sentiment. In the past six months, aggregate earnings per share forecasts for S&P 500 companies have increased by 1.4%, while sales estimates have risen by just under 1%. However, estimates for profit margins have only slightly increased due to the moderation of higher staff pay. Additionally, upward revisions to earnings per share (EPS) forecasts for 2023 and 2024 have accounted for around 58% of all revisions, up from less than 40% earlier this year.
Historically, during economic expansions, the percentage of upward revisions tends to reach around 80% after a recession. However, during times of concern over a potential slowdown, the number typically does not exceed 60% to 70%. Furthermore, early signs indicate that earnings estimates have peaked, with EPS forecasts for the third quarter of 2023 dropping by about 0.4% in recent weeks. The Federal Reserve’s potential interest rate hikes could also contribute to additional cuts in earnings estimates. Although the rate of inflation has been declining, the Federal Reserve is expected to maintain elevated rates, which may negatively impact the economy and company sales.
These developments are particularly significant considering the current expensive valuation of the stock market. The S&P 500 is trading at approximately 18 times the expected EPS for its constituent companies over the next twelve months, compared to just over 16 times at the beginning of the year. The stock market’s optimism regarding earnings growth, reflected in an increased ratio despite rising bond yields, implies potential downsides if analysts reduce EPS estimates. Investors should approach the market with caution.
Overall, the article highlights the likelihood of falling corporate earnings forecasts and its potential impact on the stock market. While analysts have been positive, recent data suggests a shift in sentiment. This comes as EPS forecasts have increased, albeit at a slower pace than sales estimates. The percentage of upward revisions in earnings forecasts has also risen, indicating optimism. However, signs of peaking earnings estimates have emerged, which could be exacerbated by potential interest rate hikes. Considering the already expensive valuation of the stock market, downside risks are present if EPS estimates are cut.