For quite some time now, one bank’s leading earnings indicators have tipped a marked deceleration in corporate profit growth.
It’s actually not just one bank’s indicators. Several sell-side EPS models suggest consensus is too sanguine about the likely depth and duration of the current profit contraction.
As a quick reminder: Corporate earnings in America are seen falling 9% YoY for Q1, 6% for Q2, then inflecting for the better after that.
A pair of Morgan Stanley indicators which map very well with trailing EPS growth have suggested a steep decline is on the horizon. Those indicators (shown below) help inform the bank’s bearish outlook for equities as expounded weekly by Mike Wilson.
The sharp-eyed among you will note that the indicators have inflected. As the bank put it, they’ve “flattened out” and “stabilized.” That’s due to a hodgepodge of better-than-expected macro data.
Given that Wilson has relied on those indicators to make the bearish case, you may be curious as to why he’s still bearish given that both have seemingly bottomed.
Part of the answer is that Wilson suspects investors are operating on a false premise about the read-through of the Fed’s efforts to stabilize regional banks. At the same time, he believes stocks have been buoyed by an improvement in global liquidity since October’s lows. Both the false SOMA optic and the liquidity support may fade going forward.
Beyond that, though, there are four earnings-related reasons Wilson hasn’t turned bullish despite the apparent stabilization in the bank’s earnings indicators. He enumerated those reasons as follows:
- The stabilization isn’t expected to occur until early ’24 based on our models and they still imply ’23 consensus estimates are 15-20% too high;
- It’s possible the output turns down again — we have an incomplete set of inputs for our Non-PMI LEI for March but the data points we do have suggest another leg lower;
- A much better EPS growth backdrop in ’24 has been our assumption, but in our view, we need to see a material reset first in ’23 relative to what consensus expects and what is priced;
- On that last point, the equity risk premium still has not repriced higher and didn’t during last year’s selloff. Given that this is the subcomponent of the market multiple reflective of growth expectations, we believe we should see an ERP repricing before this bear market is over.
The bottom line for Wilson is that the scope of the coming earnings decline may still be underappreciated by many market participants, and the recent re-rating (back near 19x on the S&P) makes the situation more perilous still.
