“Way” back in August, following a better-than-feared Q2 reporting season for corporate America, it was tempting to suggest that dour predictions of a corporate profit “reckoning” were overblown. That rumors of an earnings recession were just that — rumors.
Fast forward a few months, and although the bottom hasn’t fallen out in earnest, Q3 results were lackluster, stoking renewed worries and prompting prominent top-down strategists to cut their earnings outlook for 2023.
By now, regular readers are familiar with this ongoing saga, which I still believe will end in a fairly deep profit contraction by the time the final chapter gets written.
When you think about the outlook for earnings amid persistent calls for crimped profits, it’s important to note that we’re nowhere near the average when it comes to the timing of a typical earnings recession vis-à-vis the revision cycle. The figure (below) illustrates the point.
These episodes are painfully slow to play out, with the exception of 2020 (for obvious reasons).
“Prior earnings recessions have taken 15 months to materialize, on average,” Morgan Stanley’s Mike Wilson, who harbors one of the more pessimistic outlooks for index-level EPS in 2023, noted. “While it feels like this downward revision cycle has been in process for a long time, we’re only about four months in from the early-July peak in numbers,” he added.
Read that again. It’s been just four months since peak forward EPS. During the financial crisis, it took 18 months for forward estimates to trough.
There’s no mystery as to what “informs” (or misinforms) the lag. “It typically takes time for bottom-up consensus expectations… to reflect the top-down earnings risk,” Wilson remarked, noting that consensus is “informed by corporate views.”
Of course, management isn’t excited about delivering bad news to shareholders, so you can’t depend on the C-suite to be ahead of the game when it comes to tipping the market off on nascent macro risk and the implications for corporate bottom lines.
But company analysts are, ostensibly anyway, supposed to flag such risks to investors. If they’re taking their cues from management, they’ll be behind the proverbial curve, which raises uncomfortable questions about their usefulness.
Wilson went on to say that “the market discount[s] earnings downside somewhere between ~40-50% of the way through the EPS compression,” suggesting markets will fully price the EPS move during the first quarter when, as Wilson also noted, companies will be guiding for full-year 2023 EPS alongside Q4 2022 results. That, he said, is “a negative catalyst in our view.”
Remember, though, the market rarely assigns a trough multiple to trough earnings. If there’s a saving grace in the above, that’s it.
Could you please comment on the potential paths/timing of the change in earnings multiples? Regards