I dare say earnings reports from retailers will be among the most important macro events in the new week.
Last week’s losses for US shares were brought to you in part by guidedowns from Walmart and Target, along with a handful of similarly dour reports from Ross and Kohl’s, among others. The market will hear from department stores, dollar stores and discount stores this week, as well as big names like Gap and Ulta.
Generally speaking, I’d expect to hear more of the same. Consumers are pivoting away from discretionary purchases as higher costs for food and fuel erode household budgets. Margins are under pressure and supply chain snarls are pervasive.
Companies on deck to report in the days ahead run the income spectrum gamut. The color from management could prove to be more important than Friday’s personal spending and income data for April. The micro is now the macro. As one reader mentioned last week, Costco could be a bright spot, but it’s difficult to imagine investors making it through the week without seeing a few additional guidedowns.
That’ll keep the consumer retrenchment story topical, which in turn means the voluble recession crowd will likely come away with more evidence to support the case for a downturn. The median S&P EPS decline in post-War recessions is 13% (figure below).
The median rebound is 17%.
Needless to say, analysts haven’t incorporated anything like this into estimates yet. “During the last four recessions, the typical revision to consensus EPS estimates during the six months prior to the start of a recession has ranged from -6% to -18%, with a median of -10%,” Goldman’s David Kostin wrote, adding that “during the six months following the start of the recession, analysts reduced EPS estimates by an additional 13%.”
A more granular look at profits during recessions shows the median trough, on a quarterly, YoY basis, was a decline of more than 20% (figure below).
For what it’s worth, stocks arguably are pricing an earnings drop consistent with an economic contraction, even if analysts aren’t collectively ready to sign the expansion’s death certificate. “In terms of earnings growth, at the recent lows the market was in line with earnings falling -20%,” Deutsche Bank’s Binky Chadha said. He looked at the S&P versus its one-year moving average and YoY EPS growth excluding the Trump tax cuts.
If you look at the 12-month window capturing the six months leading into a recession and the six months following the onset of a downturn, analysts cut estimates by a median of 22%, according to Goldman.
It’s worth noting that some companies probably over-earned post-pandemic. If that’s the case, you could argue that 2021 EPS isn’t necessarily the best reference point — that if we’re going to extrapolate an S&P target using a “20th century multiple” (as BofA’s Michael Hartnett suggested), or speculate about how far aggregate index profits might fall based on historical declines during recessions, we should us pre-pandemic EPS levels.
That’s fair, but as Deutsche’s Chadha noted, earnings almost always rise above their long-run trend during upcycles (figure on the left, below).
That said, the figure on the right (above) shows that consensus currently expects profits to rise even further above trend, to levels consistent with the most extreme historical overshoots.
Looking ahead, it’s notable that the size of equity drawdowns around recessions is well explained by the severity of the downturn and the scope of the overvaluation in stocks prior to the selloff. US shares traded at (or near) their richest valuations in recorded history on the eve of the current drawdown.
“While the excess valuation premium has largely been wrung out, it is not yet low, and valuation concerns are now giving way to earnings concerns,” Deutsche’s Chadha went on to say. “Forward estimates have begun to be downgraded but remain well above prior trend levels, leaving them vulnerable.”
Finally, I’d note that the first two figures (above) don’t suggest we’ve been particularly successful in “smoothing out” the business cycle. Peak-to-trough earnings declines are getting larger and the rebounds more spectacular. The frequency of downturns may be decreasing, but their magnitude is increasing. Some might consider that problematic. Others might call it policy failure.
