Companies are set for a difficult reporting season as macroeconomic risks including slowing demand and soaring costs build, according to Goldman Sachs Group Inc. and Morgan Stanley strategists.
“Things like inventory, labor costs and other latent expenses are wreaking havoc on cash flow,” a Morgan Stanley team led by Michael Wilson -- one of Wall Street’s staunchest bears -- wrote in a note. “The market has started to see cracks with some bellwether stocks reporting both top-line and bottom-line misses in recent weeks.”
Meanwhile, a surging US dollar, headwinds to margins and tax changes are the three key risks to upcoming earnings reports, according to a separate note from Goldman strategists.
The stronger greenback has historically been linked to fewer sales beats, strategists led by David Kostin wrote in a note, pointing to Levi Strauss & Co., which missed estimates last week partly due to the soaring currency. Continued dollar strength “would support the performance of stocks with 100% domestic sales relative to those with a higher proportion of foreign sales.”
A Goldman basket of stocks that derive 100% of revenues domestically has outperformed the one that gets 71% of revenues from sales outside the US in 2022.
Nevertheless, all companies are navigating several headwinds this year like rising inventory, higher rates and slowing demand as the Federal Reserve maintains its hawkish stance. Bloomberg’s latest MLIV Pulse survey showed the majority of investors expect this reporting season will push the S&P 500 Index lower with respondents seeing references to inflation and recession dominating earnings calls.
“An inventory glut will weigh on margins if the macro environment deteriorates,” the Goldman strategists wrote. Meanwhile, the Inflation Reduction Act which imposes a 15% minimum tax on corporate book income and 1% excise tax on buybacks starting in 2023 will also weigh on S&P 500 earnings, they said.
The Goldman team expects there to be fewer positive surprises in the third quarter compared to the first half of this year, with negative revisions to the fourth quarter and 2023 estimates.
“The bear market will not be over until the deteriorating fundamental picture is more fully discounted,” Morgan Stanley’s Wilson wrote. Sentiment will be impacted “when companies throw in the towel” or if there’s an external financial shock.
Separately, Sanford C. Bernstein strategists Sarah McCarthy and Mark Diver said there’s further downside to come for US and European stocks, as earnings estimates and investment flows out of equity funds haven’t bottomed yet.
This article was provided by Bloomberg News.