‘Professional Prognosticators’

The smartest among us admit how little we know and, as a corollary, acknowledge that making predictions is mostly impossible outside of the hard sciences.

That latter bit isn’t technically accurate. Making predictions is possible. Making accurate predictions isn’t. Indeed, even predictions based on science are subject to missing the mark. Just ask a meteorologist.

Speaking of meteorologists, Wall Street’s weathermen and women are still pretty confused, collectively anyway. The figure (below), shows the difference between the most bullish and most bearish S&P 500 forecasts.

Nearly 25% separates the guesstimates of the most optimistic and most pessimistic “professional prognosticators,” as Bloomberg somewhat euphemistically described strategists in a new piece.

I suppose I’d suggest there’s no such thing as a “professional prognosticator.” Or, actually, there is. But you won’t find them on Wall Street. You’ll find them in tiny, one-room shacks, the curtains drawn on windows with neon “tarot card” signs, like something out of Mickey Rourke’s nightmarish adventures in Angel Heart. (If you haven’t seen Angel Heart, don’t. It’s like the original Jacob’s Ladder — not immediately terrifying, but very uncomfortable and likely to leave an unwelcome lasting impression.)

You certainly don’t need me to enumerate the concerns facing a market that trades on some of the most daunting multiples ever witnessed. And if you do need to have the “litany of concerns” enumerated, I obliged in “Autumn ‘Flash Recession’“.

From a strictly fundamental perspective, it’s possible to argue that you can’t argue with profits. And earnings are robust, to say the least.

The problem with that is twofold.

First, the beat rate witnessed during Q2 reporting season was itself a product of “professional prognosticators'” inability to accurately forecast during one of the most uncertain periods for corporate America in decades. So there’s a bit of circularity in the argument that “blowout” earnings justify runaway optimism.

But perhaps more importantly, Q2 was a margins story. Overall, they (margins) improved more than 350bps compared to Q2 2020. 12.1% was a record and a full 100bps above forecasts.

Read more: Hello, Blockbusters!

As I wrote in that linked article, if margins are what matters, you might fairly ask whether things are about to get a lot more challenging. After all, cost pressures are rampant and many expect wage bills to rise further as labor remains in short supply. As Bloomberg’s Katherine Greifeld wrote Saturday, some “say the recovery faces too many obstacles, including margin pressure from inflation and Joe Biden’s proposed tax hike, to warrant faith that companies will continue to deliver.”

One person who’s baking in higher taxes is Morgan Stanley’s Mike Wilson, who last week was effectively forced to lift his profit forecasts, even as his index-level targets were basically unchanged. In a separate note, Wilson analyzed transcripts (among other things) to discern “what companies are saying.” It certainly won’t surprise anyone to discover that “transcript mentions of ‘cost inflation’ are at all time highs” (left figure, below, from Morgan).

Relatedly, Wilson noted that the percentage of companies fretting about labor shortages is off the charts (figure on the right).

Obviously, that’s a risk to margins. “Intentions to raise wages amid the labor shortage are accelerating,” Wilson remarked, adding that “in response to inflation pressure, companies are raising prices at a historic clip.”

The question, then, is simply whether it’s possible to offset surging input costs, wage pressures and, potentially, higher taxes, with price hikes. The answer is probably not, or at least not fully. The figure (below, from Morgan) is actually really informative.

“Our work shows that margins consolidate after a surge in ‘cost pressure’ mentions,” Wilson said, noting that’s consistent with the bank’s view “that bottom up consensus margin estimates for year-end 2021 and 2022 have downside risk.”

Wilson, one of Bloomberg’s “professional prognosticators,” has a year-end S&P target of 4,000. Fans of Mike’s fondly recall 2018, when he predicted a “proper rain storm” just three months before US equities careened into a mini-bear market following Jerome Powell’s ill-fated “long way from neutral” misstep and Donald Trump’s trade war escalations.

Jackson Hole is next week.