On Friday, the S&P 500 surged past its all-time closing high, which was set at 2,130.82 on May 21, 2015.
Bank of America Merrill Lynch (BAML) analysts have actually cut their S&P 500 earnings forecasts to reflect no growth on 2016.
“In the wake of the weaker-than-our-expected 1Q results and recent macro headwinds, we are trimming our S&P 500 EPS forecasts by 3% in 2016 and 2% in 2017,” BAML’s Dan Suzuki said. “Our revised forecasts of $117 (flat y/y) in 2016 and $125 (+7% y/y) in 2017 suggest downside to the bottom-up consensus of 1% and 7%, respectively.”
Like BAML, most analysts are expecting an earnings rebound in the second half of the year and 2017,. But these forecasts have been called into question given the increasingly uncertain macro environment.
Future earnings growth is arguably what’s really underpinning the market’s valuation right now, given that FactSet’s John Butters notes that the market’s forward P/E (based on the higher consensus estimates) is currently 16. – which is higher than both the 5 and 10 year average for the market.
BAML’s conservative earnings estimates give the market an even higher forward P/E of 17.9. This high valuation, combined with poor growth expectations, led BAML to slap the S&P 500 with a price target of 2000. Currently the S&P is at 2130, which leaves 5.8% downside risk for investors.
Once you strip out the energy sector, BAML actually expects 0% earnings growth in 2016 and 4% in 2017, which is even lower than their overall estimates. Due to how much the price of oil fluctuates, the energy sector has rather volatile earnings, making it hard to predict earnings so far in advance.
Financials, Tech, Industrials, and Energy are all expected to struggle in 2016, given their global exposure; the stronger dollar will depress international earnings. However, the dollar is expected to start stabilizing in 2017, which should help boost multinational earnings.
JP Morgan’s equity strategy analysts are a bit more bullish on 2016, but also believe that 2017’s estimates are far too aggressive, modeling 5% growth vs. the consensus 14% growth. They are also expecting further negative revisions to earnings estimates once companies start giving guidance for the rest of the year during the upcoming earnings season.
JP Morgan notes that there is historical precedent for this: “Over the last ten years, the consensus growth estimate for the following year was typically revised down by ~5%.”. The downwards revision is expected to be even more pronounced for 2017 due to “unrealistic assumptions,” such as “7% sales growth and +50bp margin expansion.”
A big problem with modeling future earnings growth arises from the uncertainty created by macroeconomic events such as Brexit, Chinese economic data, the price of oil and the upcoming presidential election. These can all have negative effects on earnings, as companies are uncertain whether it would be wise to invest, and thus end up investing less in aggregate. Investment is often what causes future earnings growth, which is why 2017 estimates in particular may be too bullish.
The underlying message to all of this is that investors need to pay close attention to guidance during Q2, and be prepared for the market to correct a bit, if it looks like earnings won’t be as rosy as the consensus estimates are. At the very least though, all analysts do agree that corporate America should be able to break their 5 quarter losing streak, and show some growth in the upcoming quarters.
Rayhanul Ibrahim is a writer for Yahoo Finance.