The latest data indicates that Wall Street’s predictions for corporate earnings are set to decline, which could have a significant impact on the stock market. Analysts have been optimistic about profits, but there is a shift in sentiment occurring. On one hand, earnings per share forecasts for companies in the S&P 500 have seen a modest increase in the past six months, with sales estimates also rising slightly. However, a closer look reveals that the percentage of upward revisions to earnings forecasts for 2023 and 2024 has recently increased to 58%, signaling a potential peak. While historically this figure has reached around 80% after a recession, it tends to remain below 60% or 70% during prolonged economic growth with concerns of a slowdown. As a result, cuts to forecasts may start to play a bigger role in revisions.
As evidence of this potential decline, estimates for third-quarter EPS for S&P 500 companies have already declined by 0.4% in the past few weeks. Analysts are expecting further cuts in the near future. The situation may worsen if the Federal Reserve continues its interest rate increases, as higher rates tend to have a delayed negative impact on the economy and company sales. This economic weakening, combined with the already expensive nature of the stock market, raises concerns. The S&P 500 is currently trading at 18 times the expected EPS for the next twelve months, compared to just over 16 times at the beginning of the year. The market’s optimism about earnings growth becomes evident when considering that this ratio has continued to rise despite the increase in bond yields, which typically devalues future profits. Thus, there is a significant downside risk for stocks if analysts continue to revise EPS estimates downwards.
In conclusion, the stock market faces a major problem related to corporate earnings. While previously optimistic, Wall Street’s forecasts for earnings are likely to decrease, potentially leading to a decline in the stock market. The overall sentiment has shifted, with data showing a slight increase in earnings per share forecasts for S&P 500 companies but a more significant rise in the percentage of upward revisions. However, this increase falls short of historical peaks, which usually occur after a recession. Recent signs already indicate a peak in earnings estimates, with a decrease in third-quarter EPS expectations. Additionally, the potential negative impact of higher interest rates on the economy and corporate sales raises concerns. The current expensive valuation of the stock market and its optimism about earnings growth suggest a significant downside risk if analysts continue to revise EPS estimates downwards.
