Mike Wilson Asks: ‘Do Earnings Matter?’

Morgan Stanley’s Mike Wilson has a question. Maybe you can answer it.

“Do earnings matter?” he wondered, in a note published Monday.

I’d like to tell Mike that they do, but the truth is… well, the truth’s complicated.

“With year-to-date returns driven nearly 100% by multiple expansion, the market either doesn’t appear to care about earnings, or it expects a major reacceleration in growth both later this year and next,” Wilson wrote, in a sweeping preview of a US reporting season which consensus expects could mark the trough for an earnings recession that may already be over.

In the linked article, I mentioned Wilson in the context of skeptical strategists who aren’t necessarily buying the notion that Q2’s results will indeed constitute the worst of the YoY decline in aggregate corporate profits. On Monday, Wilson suggested that “better than feared” won’t be good enough going forward, an allusion to the notion that corporate America made it through the last two reporting seasons by clearing a lowered bar.

Morgan Stanley doesn’t expect results to disappoint. In part because the bar was lowered headed in. But the bank cautioned that the trough in EPS growth could get pushed out into Q3, which is when the bank’s forecast “really starts to diverge from consensus.” “So the key for stocks will come via company guidance for the out quarter rather than the Q2 results themselves,” Wilson wrote.

By now, everyone with even a passing interest in markets can recite some basic version of the Wilson earnings bear case and how it’s developed over the past 12 or so months. Suffice to say the negative operating leverage thesis played out, and the US did in fact enter a profit recession, but it was offset by multiple expansion and we’ve now reached something like a moment of truth: Either earnings growth begins to inflect in Q3, or not.

Currently (and I’ve mentioned this on several occasions over the past week), revisions breadth is improving, and that’s helped bolster equities, but Wilson noted there hasn’t been “a notable increase in forward EPS forecasts.” There is, of course, a tight relationship between performance and revisions.

The red annotation in the visual above is mine. “At this point, the S&P 500 appears to be pricing in a higher level of earnings revisions breadth than what has transpired, further supporting our view that Q2 earnings season will be more about the guide than usual,” Wilson remarked.

So, in other words, it all hangs on what management says about the outlook. Will they, or won’t they, venture out onto what Wilson seems to consider a shaky limb?

“The question is will companies in aggregate be willing to take forecasts up from what appear to be too high levels already based on our models — i.e., flat growth YoY in Q3 and +8% growth YoY in Q4?” he asked.

In Wilson’s view, “stocks will need more confirmation of the turn in growth than they have over the past six months given higher valuations, deteriorating liquidity and proximity to the second half when consensus expects a recovery.”