Over the past few weeks, some have noticed that analysts have been revising down their expectations for corporate earnings.
The chart above comes from Citi (reproduced by Bloomberg.) From Bloomberg’s story:
Citi strategists led by Jamie Fahy said a global gauge tracking analyst estimates on corporate profits has turned negative for the first time since September 2020. This is a potential “game-changer,” eroding their conviction on the prospects of risk assets, they wrote.
For U.S.-focused investors, the narrative is essentially the same. You can read about it in FactSet’s March 4 report titled: “Largest Decrease In EPS Estimates For S&P 500 Companies Since Q2 2020.”
The missing context tells a different story
John Butters, the analyst who wrote the FactSet report, makes very clear that while this recent 1.2% negative revision represents the largest decrease in earnings estimates since Q2 2020, the size of the decrease is actually smaller than historical averages. From Butters:
In a typical quarter, analysts usually reduce earnings estimates during the first two months of a quarter. During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 2.0%. During the past 10 years (40 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 2.7%. During the past 15 years (60 quarters), the average decline in the bottom-up EPS estimate during the first two months of a quarter has been 3.5%.
Brian Belski, chief investment strategist at BMO Capital Markets, charted this in a research note published on Thursday. Think of it as the chart above, but zoomed out.
“We are back to pre-pandemic norms of analysts’ estimate revisions, where they cut numbers through a quarter such as the current one,” Nicholas Colas, co-founder of Datatrek Research, wrote last Monday. “On its own, that is no reason for concern. The upward revisions for the 5 quarters after the Pandemic Crisis low were typical of what happens in the early stages of an economic recovery; analysts underestimate both revenues and incremental margins. We are past that phase now, and that’s entirely understandable.”
In fairness to the Citi data cited by Bloomberg, I don’t know exactly how they’re calculating their index. Their historical data may be reflecting something different.
The bottom line is that cuts to earnings expectations are normal. And keep in mind that the S&P 500 rallied during most of these periods where earnings estimates were cut. (I’ve been writing and tweeting about this for the last ten years.)
The big picture
Revisions applied to earnings estimates don’t actually tell you much about earnings — they tell you whether analysts felt they were too optimistic or too pessimistic about their own prior estimates.
That said, there are two more important observations worth noting.
First, most companies usually report earnings that beat these estimates. Check out the chart below from Deutsche Bank’s Binky Chadha. (For more, read: 'Better-than-expected' has lost its meaning 🤷🏻♂️ )
Second — and more importantly — while there are some negative revisions happening for certain quarters, expectations for future earnings continued to be for growth. Check out the chart below from FactSet.
“Annual earnings estimates have also held up well,” Belski wrote. “In fact, the 2022 bottom-up consensus EPS forecast for the S&P 500 index has actually been revised higher by 1% through the first two months of the year (and +0.2% in March), a positive trend that has largely been overshadowed in recent weeks amid the ongoing market turmoil.”
There’s certainly no guarantee that earnings growth will hold up as analysts are forecasting.¹ But considering the massive tailwinds currently blowing in the economy, it’s not surprising to see that these longer-term forecasts haven’t come down in a more noticeable way.²
Relevant reading from TKer:
Bonus: I spoke about this and other big topics on “The Compound & Friends” podcast with Alison Schrager and Ritholtz Wealth Management’s Josh Brown and Michael Batnick. It’s available on iTunes, Spotify, and Google Podcasts. Don’t miss it!
📉 Stock market falls: The S&P 500 fell 2.9% last week. The index is now down 12.7% from its January 4 all-time high. For more on market sell-offs, read this.
⚠️ As the stock market swings wildly, keep in mind that some of the sharpest short-term rallies follow the sharpest sell-offs. This has serious implications for long-term returns. For more on this, read this and this.
✂️ Stock market target cut: On Friday, Goldman Sachs strategists cut their year-end target for the S&P 500 to 4,700 from 4,900 (which was down from an original target of 5,100). From Goldman Sachs’ David Kostin: “A surge in commodity prices and a weaker outlook for US and global economic growth lead us to lower our EPS estimates. Our new 2022 EPS estimate of $221 reflects 5% year/year growth compared with our prior estimate of 8% growth to $226. Our forecast 2023 earnings growth rate remains unchanged at 6% but the EPS level is trimmed to $233 (from $240).“ For more on Wall Street’s short-term targets and how they frequently get revised, read this.
🛢 Oil surges: WTI crude — the benchmark for oil sold in the U.S. — went above $130 a barrel after the Biden administration said it was in active discussions with Europe about banning the import of Russian oil. On Tuesday, the U.S. announced such a ban at home. For more on what surging energy prices mean, read this.
🎈Inflation continues to be hot: The consumer price index (CPI) increased by 0.8% in February from January. This represents a 7.9% increase from a year ago, the biggest jump since January 1982. The numbers were largely inline with economists’ expectations and it sets up the Federal Reserve to begin raising interest rates at its monetary policy meeting next Wednesday. For more on this, read this.
⚠️ The CPI report doesn’t account for the more recent surge in commodity prices that followed Russia’s invasion of Ukraine. “The Russia-Ukraine war adds further fuel to the blazing rate of inflation via higher energy, food, and core commodity prices that are turbo charged by a worsening in supply chain problems,” Kathy Bostjancic, chief U.S. financial economist, wrote on Thursday.
📈 Job openings are up: According to the BLS’s Job Openings and Labor Turnover Survey, there were 11.3 million job openings in January. This key economic metric continues to be significantly above pre-pandemic levels, which is bullish. For more on job openings, read this.
Up the road 🛣
The Federal Reserve will meet on Tuesday and Wednesday for its regular monetary policy meeting. At the conclusion of the meeting, the Fed is expected to announce that it is raising its target short-term interest rate range by 25 basis points (bp) to 0.25%-0.50%, from 0%-0.25%.
Here’s JPMorgan’s Michael Feroli: “The case for a 25bp move next week is straightforward: in last week’s Congressional testimony Chair Powell indicated that he would “propose and support” a quarter-point hike. This was a strong statement, and one made when he surely knew that CPI could come in higher or lower, or that the attack on Ukraine could intensify or subside. Thus we see little reason to think that the events since the testimony should sway us from strongly expecting a 25bp move next week.”
¹ Indeed, Goldman Sachs analysts just revised their 2022 EPS growth estimate down to 5% from a prior estimate of 8%.
² And as we say here at TKer, earnings are the most important driver of stock prices.