“Make no mistake, we don’t believe this bear market is over,” Morgan Stanley’s Mike Wilson wrote Monday.
He needn’t have been so emphatic. No mistakes were made, I can assure you of that. Or at least not vis-à-vis market participants’ perception of Wilson’s view on where we are in a selloff which, so far, is notable for a lack of capitulation despite an extraordinarily fraught macro backdrop.
There’s nothing ambiguous about Wilson’s outlook. Week in, week out, he reiterates a familiar set of talking points, which most recently revolve around the notion that although it may feel as though the bear market is behind us, it’s not. Wilson was the first to flag the inventory overhang that bedeviled retailer guidance last quarter, and continues to believe earnings estimates don’t reflect margin risk at a time when input costs are onerous, labor costs elevated and demand set to slow as inflation forces consumers to forgo discretionary purchases.
With earnings season underway, the downgrades have started. “Scanning through the reams of research that hits the inbox during the reporting season, we see that the much-anticipated demand destruction and margin squeeze is starting to come through,” SocGen’s Andrew Lapthorne said, noting that in just a few weeks, “much has changed” when it comes to earnings momentum.
Company analysts and, by extension, bottom-up consensus, were mercilessly derided headed into Q2 reporting season for falling behind the curve. Profit and margin forecasts didn’t budge despite clear evidence of a deteriorating macro environment and, in some cases, cautious commentary from management and even guidedowns. The figure on the left (below) shows where things stood as of late last month.
The figure on the right (above) provides some context for how optimistic margin assumptions were in the face of rising recession risk, unabated headwinds to profitability and an ever stronger dollar.
As Lapthorne went on to say Monday, “earnings momentum, particularly in the US, has slumped toward levels usually associated with a profit decline.” The figure on the left (below) gives you a sense of things.
Although lofty expectations for the oil & gas sector are still buoying aggregate estimates for index-level profits, Lapthorne noted that the pace of recent cuts suggests downgrades could soon hint at an earnings decline for global shares excluding energy and materials.
The figure on the right (above) is particularly problematic. Downgrades are occurring at a time when bond yields have risen. Notwithstanding the distinct possibility that recession fears will cap long-end yields going forward, that conjuncture isn’t common.
“It is rare to see both EPS being cut and WACC going higher, given that bond yields usually drop in the face of cyclical weakness,” Lapthorne remarked, adding that “with market valuations also highly polarized, equity markets are likely to continue to struggle in Q3.”
I believe that some or many investors figure that when the Fed is done raising rates, stocks will “take off”, and they expect the Fed to be done in Sept, implying we are only two months from takeoff, and wouldn’t it be embarassing to capitulate just a month or two before the bottom, plus the SP500 has been choppy-flat for over a month now, and they expect growth tech to outperform in a recession.
H-Man, it ain’t over till the fat lady sings and this is just the first Act.
Of course analysts aren’t reducing their company forecasts and downgrading companies from “BUY”. As soon as they do they are cut off from valuable access to the C Suite and other parts of the companies they cover, their firms lose underwriting business, and the stock possibly drops hurting all the C Suite stock option compensation.
Often, like economists (Who You Gonna Believe, Economists or Those Lyin’ CEO’s?), analyst recommendations should be taken with a big grain of salt. They are not unbiased.