Barely seven of the first 35 companies in the US S&P 500 index to release their second-quarter results subsequently have raised their earnings per share forecast for the third quarter. Are earnings expectations and analysts still too optimistic?
Some 77 percent of those companies saw their Q3 2022 expectations revised downwards. The average estimated change is -3.0 percent, according to The Earnings Scout.
These are the worst revised estimates since the summer of 2020. Meanwhile, European earnings forecasts remain on track, but those in the United States still appear to be quite a bit too optimistic.
Thomas Bucher, portfolio manager and equity strategist at DWS, argued in a recent paper that “recession fears are shaking capital markets to their foundations”. In the minds of investors, inflationary pressures are no longer the biggest threat, but recessionary fears.
Equities have slipped into a bear market and the crypto market is about 75 percent lower than its peak. In addition, risk premiums on corporate bonds have roughly doubled in a year and the price of copper, the metal with the best antenna for economic developments, has plunged 30 percent since the end of March. To top it all off, the dollar, which has always been considered a safe haven during uncertain times, has risen by 12 percent, noted the analyst.
Estimates largely unaffected
Despite these headaches and negative indications, equity analysts have kept their forecasts for the coming 12 months virtually unchanged. The gap between earnings expectations and share prices is quite large. In the end, the only option is for both to converge. “That is no surprise because there are three factors that ultimately determine the share price: earnings, earnings growth and the interest rate environment. But developments in the coming period will have to be very positive if share prices are to rise again in the direction of earnings expectations,” said Bucher.
The sharp correction in the markets has caused valuations to fall sharply, at least on paper. But when earnings expectations are adjusted, P/E ratios will rise again as earnings outlooks shrink. More importantly, markets will not recover until forecasts are revised downwards. “We do not expect earnings growth in industrialised countries in the coming year,” he wrote.
One reason analysts are optimistic is because they are likely to continue to believe in company forecasts. But companies hardly ever foresee economic tipping points, Bucher said, and the sharp rise in energy prices alone is enough to lower forecasts in many sectors.
There are exceptions, however. The profit forecasts for the energy sector have already risen by 40 percent this year and in the materials sector (raw materials-related manufacturing) by 10 percent. These two, along with manufacturing and IT, are the four sectors for which earnings forecasts have been revised upwards, he explained.
The vast majority of companies are hurting because of higher energy prices. Yet there have been virtually no adjustments to profit forecasts in the seven sectors into which they are classified. It would therefore be very surprising, said Bucher, if there were no substantial downward adjustments to earnings forecasts in the coming months.