A key plank of what’s left of the bull case on stocks is the sturdiness of profit estimates. But expecting such predictions to keep you out of trouble when the market goes south is asking a lot.
It isn’t that earnings forecasts don’t have their use. Most of the time they point to profit growth that does in fact materialize. Right now, the consensus view among analysts tracked by Bloomberg is for S&P 500 income to rise by 10.1% this year and 9.5% in 2023, roughly average growth for Corporate America over the years. Those figures have given comfort to people betting equities can hold firm.
The issue for investors is that there’s little precedent of such estimates changing in the runup to periods of market stress. The most famous example is the eve of the 2008 financial crisis, when Wall Street prognosticators pegged the increase in earnings at 15% over the next 12 months. A rosy outlook also prevailed in December 2014, before profits slid and stocks had one of their worst stretches of the bull market.
“Earnings are like Wile E. Coyote. They’re running, and then just as there’s no land underneath them, all of a sudden, they look down, and then they plummet,” Sam Stovall, chief investment strategist at CFRA, said by phone.
Stocks have been hit on multiple fronts this year: inflation and the Federal Reserve moving aggressively to tamp it down, the war in Ukraine, slowdowns in China and continued supply-chain disruptions. So a common, comforting refrain heard during the latest earnings season was that at least Corporate America is in good health. Profits aren’t rising at the same pace clocked last year, but they’re still going up.
But stock prices tend to lead changes in economic fundamentals, according to Stovall, and the latest selloff is indicative of investors going through the process of figuring out whether the economy will be in any condition to sustain 10% profit growth.
To Jerry Braakman, chief investment officer and president of First American Trust, it makes sense the market has dropped almost 15% since the start of the year. “Stocks trade on the future,” he said by phone. And right now, the outlook is murky as the Fed gets restrictive to combat inflation.
Prominent economists have been sounding the alarm that the central bank is behind the curve and likely won’t be able to avoid contracting the economy severely. Its actions will lead to a deep U.S. recession next year, according to Deutsche Bank, and the unemployment rate could rise by several percentage points.
That doesn’t mean profit forecasts don’t have any use, said Art Hogan, chief market strategist at National Securities, but they have had trouble sussing out when the economy is about to enter a downturn.
“Where we miss it the most is at key turns in the economic cycle,” Hogan said in an interview, venturing that there’s still a better-than 50:50 chance estimates are going to be right this year now that strategists and analysts have fresh information on second-quarter and second-half outlooks.