Delaying The Inevitable (Enigmatic Dreams Of A Better Future)


That’s the best way to describe second quarter earnings season in the US, where the combination of corporate pricing power and a purportedly resilient consumer kept aggregate profits a semblance of buoyant despite the most challenging macro backdrop in modern history.

Headed in, many top-down strategists assumed earnings (and particularly revisions) were the next shoe to drop in the bear market. The same strategists generally thought this was the quarter when that shoe would fall.

But it didn’t quite work out that way. Instead, Q2 EPS managed a decent beat (with ~75% reporting), and while some companies’ guidance did validate concerns about margin headwinds ranging from a firm dollar to bloated inventories to elevated labor costs to legacy supply chain frictions, it wasn’t an across-the-board affair.

Say what you will, but Q2 wasn’t the “kitchen sink” moment. In fact, with 71% of index earnings on the books, there were more above-consensus guides than below-, according to BofA’s tracker. The uptick in the guidance ratio through week three of reporting season was “the biggest positive surprise,” the bank’s Savita Subramanian said.

Still, she noted that BofA’s earnings revision ratio is “tracking at the weakest level since April 2020. The bank sees aggregate earnings of just $200 in 2023, some 20% below consensus. Corporate sentiment, as measured by the bank’s predictive analytics team, “plummeted,” which, when plotted with YoY profit growth (on a lag), doesn’t bode well (figure on the right, below).

Meanwhile, management mentions of the word “better” or “stronger” outnumbered mentions of “worse” or “weaker” by one of the smallest margins in two decades, even as mentions of “optimism” were above average.

Consistent with the plunge in corporate sentiment, Subramanian said mentions of weak demand rose to levels nearly on par with the COVID crash and the financial crisis. And yet, “analysts are still penciling in earnings growth accelerating in 2H-2023,” she remarked, somewhat incredulous.

Suffice to say Subramanian, like her colleague Michael Hartnett, and like Morgan Stanley’s Mike Wilson, is highly skeptical of the notion US equities have seen the lows. “We need more EPS cuts,” she said, referencing the figure (below).

In recent recessions, stocks didn’t bottom until estimates were revised lower (in 1990, they were flat). “Cuts are just starting and fwd EPS is still up 7% since the market peak,” Subramanian said. The emphasis was in the original note.

Earlier this week, Morgan Stanley’s Wilson delivered another of his signature critiques vis-à-vis the inevitability of estimate cuts. “Assuming the market has already discounted a potential 15-20% decline in NTM EPS forecasts and is looking through the trough is a big mistake in our view,” he said.

One argument from the bullish camp is simply that stocks have already priced in downward revisions. I’m skeptical if for no other reason than that it appears to be an exercise in double counting. That is: Did the de-rating witnessed over the first half of 2022 serve two purposes? Did it embed higher rates into equities and account for a slowdown in corporate profit growth?

Wilson is looking to three key indicators going forward: The 3M10Y curve, EPS forecasts and PMIs, which together could suggest a soft landing is possible — or not.

EPS cuts would likely come to 20% in a recession, and PMIs would end up below 45. Currently, Morgan’s lead indicators point to a “further deterioration” in key metrics.

“The equity market can and will dream of a better future as rates come down from a potentially more dovish Fed until it is proven wrong by estimates collapsing as they always do in an actual recession,” Wilson wrote. “We continue to think the timing for that accelerated decline is likely during September/October when third quarter results further disappoint and companies can no longer push out inevitable cuts.”

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11 thoughts on “Delaying The Inevitable (Enigmatic Dreams Of A Better Future)

  1. So far it appears that declining interest rates out the curve are offsetting possible earnings cuts. Well the FOMC is going to push rates, at least somewhat in the front of the curve it appears. LIkely the consumer is resilient because of borrowing against credit cards- reportedly credit card balances are up 13%. Either some folks will max out their lines or card companies may cut them if credit gets a little dicier. I think the bears will be proven right given enough time- just looks like a correction to this (I think bear market) rally may take a little longer. The longer this takes the uglier a correction could be (either in percentage) or duration. Not trying to scare anyone- one thing you can always count on is fluctuation.

    1. It did, but as I always try to emphasize, this isn’t set up the way the vast majority of market participants seem to think it is. The granular take on the S&P at JPMorgan generally comes from Dubravko Lakos-Bujas. So, his latest was: “Strategy: Equity Valuation – Multiples vs. Rates and Growth,” for example. Marko is Chief Global Markets Strategist and Co-Head of Global Research. So his purview is pretty much everything. But the vast majority of what’s attributed to him every week is from the bank’s “JPMorgan View” weekly, which is just a summary of recent cross-asset research. The best way I can describe this is to just say that what you used to hear about when you read about Marko’s notes were his “old” QDS notes — those are the ones that earned him the wizard nicknames. What you’re seeing quoted more and more often these days (basically since his promotion) are these weekly research digests. They’re in no way comparable to those QDS notes from yesteryear. They’re not the same thing as dedicated US equity strategy notes from Goldman’s David Kostin or Morgan’s Mike Wilson either. Again, they’re just summaries. CNBC and Bloomberg really are mischaracterizing the whole setup because they want the web traffic that comes from putting Marko’s name in a headline. Every bank has some version of a weekly research digest. I’ve never seen the media quote those. They do it with JPMorgan View for one reason and one reason only: Marko clicks. There’s nothing “wrong” with that, per se, it just is what it is.

  2. I track SP500 reports, by % of names and of market cap that beat, miss, raise, lower.

    What I have for C2Q is that appx 70% (by name) and appx 65% (by market cap) beat consensus EPS, about same for cons revenues.

    Looking ahead to C3Q appx 30% (by name) and 20% (by market cap) now have cons EPS higher than it was before reporting, vs appx 40% (by name) and 30% (by market cap) for cons revenues.

    Make of that what you will. In general my feeling is that, it was overall a meh quarter.

    Fed hikes, Russia invasion, etc only started a few months ago – it feels like a long time, but it wasn’t.
    These are the 500 biggest and best companies in the strongest (large) economy in the world, so their wheels aren’t going to come off in just one quarter.

    1. “Fed hikes, Russia invasion, etc only started a few months ago – it feels like a long time, but it wasn’t.
      These are the 500 biggest and best companies in the strongest (large) economy in the world, so their wheels aren’t going to come off in just one quarter.”

      Well said.

    2. What I have for C1Q22 is that appx 75% (by name) and appx 77% (by market cap) beat consensus EPS, a little lower for cons revenues. Looking ahead to C2Q at that time, appx 50% (by name) and 40% (by market cap) had cons EPS higher than it was before reporting, vs appx 60% (by name) and 45% (by market cap) for cons revenues.

      What I have for C4Q21 is that almost 80% (by name) and appx 85% (by market cap) beat consensus EPS, but lower for cons revenues. Looking ahead to C1Q22 at that time, appx 60% (by name) and over 60% (by market cap) had cons EPS higher than it was before reporting, vs appx 70% (by name) and appx 75% (by market cap) for cons revenues.

      My tracking is not sophisticated and may have errors. For example, if a company pre-announces, my numbers look at the report vs the revised consensus, rather than vs the consensus before the preann.

      Broadly, though, I see beat-raise momentum slowing over the last couple-few qtrs.

  3. We’ve been moored on the subject of Fed policy actions while the economy continues to show crazy-good, performance. I enjoy it. But we have not spoken about Russia for a while.

    There’s encouraging, updated information from Fortune Magazine about the Russian economy, sharing their take on the impact of western sanctions there. It will become sad and difficult for the Russian people over time, as we might expect.

    Needless to say, whenever it may happen, we will all breathe a sigh of relief when there is peace in the Ukraine. But that will require removal of Putin from power, which is not foreseeable at the moment. But if circumstances in Russia continue to swirl down the Russian toilet, capitulation by the Russians in some form should be only a matter of time. I anticipate 6-9 months of cold winter and many more deaths, sadly.

    The entire war is a wholly unnecessary charade, driven entirely by Putin’s madness. In the end, Ukrainian infrastructure will be in ruins from the weapons of war. But a country that formerly called itself socialist, Russia, will be completely devastated socially and economically. And Putin and the Russian oligarchs could not care less.

    1. I don’t think the war in Ukraine and the sanctions on Russia will end at the same time. It is in the West’s interests to maintain enough sanctions to keep choking Russia’s industrial economy including its defense industry.

  4. As long as Putin is in charge I think Russia will be viewed as a pariah. It would take a real reversal of Russia’s policy and a concerted effort to help rebuild Ukraine and a complete removal of Russian forces to get the rest of the world’s attention. But Putin must be out of the picture altogether.

NEWSROOM crewneck & prints