Stocks are much cheaper than six months ago and earnings estimates remain robust. Can earnings save the stock market?
Probably not, according to multiple strategists. FactSet data shows the S&P 500 is trading below its five and 10-year valuation averages. Furthermore, forward earnings estimates are essentially unchanged from six months ago.
The problem, as Barclays points out, is optically cheaper valuation ratios are misleading if based on peak earnings. The MSCI World index is “only” down 22 per cent, compared to an average fall of 35 per cent during a recession. Fund flows follow earnings, says Barclays, which means investors “could start selling equities in size” if they lose faith in the profits outlook.
Morgan Stanley is similarly sceptical about the idea that earnings strength will be durable, saying a “profits recession” is coming. Many companies “over-earned” last year, following the rapid V-shaped recovery, and so will have to give up some of those gains. Furthermore, it adds, surveys measuring CEO confidence show it has collapsed to levels that have historically coincided with profits recessions.
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Higher rates and lower liquidity haven’t yet impacted company earnings to any great degree, but they will. This is echoed by BlackRock, which says profit-margin pressures are a risk to earnings. It appears that while analysts agree recession risks are rising, many haven’t yet priced these increased risks into the earnings of the companies they cover. Earnings estimates must come down, meaning stocks are overpriced.
