Analysts have begun to revise their earnings forecasts downward, but it doesn’t seem to be enough

Published on July , 26th 2022Market and research
Flageollet

Stéphanie BIGOU

Portfolio Manager

Intended for Professional Clients in accordance with MIFID.

Written on 21st July 2022 by Seeyond

Analysts have begun to revise their earnings forecasts downward, but it doesn’t seem to be enough.

Let’s look at the facts:

During an economic slowdown, macroeconomic leading indicators are usually the first to adjust. They are followed by the earnings estimates and equity markets. Where are we today?

  • Key macroeconomic leading indicators are adjusting drastically downward in most of the developed world, including the US, from consumer sentiment to small and medium-sized business confidence to large company surveys.  
  • Historically, analysts revise their earnings forecasts nine months behind business confidence.
  • In the case of the US, the decline in the ISM manufacturing index has been substantial in recent months, falling from 60.8 in November 2021 to just 53 in early July 2022. Furthermore, the breakdown of the latest ISM survey shows extreme fragility, which does not bode well for an imminent sustainable recovery in the companies sentiment.
  • Analysts have begun to revise their earnings estimates downward, but the correlation between the ISM and earnings outlook growth suggests that analysts will be forced to further revise their forecasts down in the coming weeks.

What do we think?

  • Profits depend mainly on three factors: sales volume, margins and pricing power, and financial conditions. Each of these three factors appears to be at risk in the short term. In particular, in the US: the fall in real wages is a brake on household purchasing power and propensity to buy; the gap between producer price inflation (PPI) and consumer price inflation (CPI) in the US is at its widest level since the 1950s, which should rapidly cap the pricing power of companies; the Fed hiking cycle is not yet over and nominal long-term interest rates are set to rise further, mechanically penalizing profits. In addition, the appreciation of the US dollar and strong currency volatility are hampering the competitiveness of US companies and accumulating losses when repatriating activities carried out abroad.
  • According to our valuation models, equity markets are not yet pricing a continued downward earnings revisions. All else being equal, with the non-restrictive hypothesis of US 10-year rate at 3% on the MT, the return of earnings growth estimates between 0 and -20% would justify a SP500 adjustment of between -10% and -25% (from the current 20/07 level at 3950) to make it attractive again to investors, in a medium-term perspective.

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Source: Bloomberg, Seeyond – Data from January 1995 to end July 2022 – Monthly data

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