Wall Street analysts’ predictions of corporate earnings are expected to decrease, leading to a potential downturn in the stock market. While analysts have been optimistic about profits, the sentiment is starting to shift. Two different viewpoints on the data highlight the recent level of optimism. Earnings per share forecasts for companies in the S&P 500 have seen a slight increase over the past six months, while sales estimates have risen slightly and profit margins have also improved. Additionally, a higher percentage of upward revisions to forecasts for 2023 and 2024 EPS for companies in the S&P 500 indicates growing positivity. However, during periods of economic growth and concern about a slowdown, this percentage tends to stay below 60-70%, suggesting potential cuts to forecasts. Early signs are already emerging as earnings estimates for the third quarter dropped slightly, and further cuts are expected.
As the economy weakens due to higher interest rates, more cuts to earnings forecasts are likely. Although the Federal Reserve might be concluding its interest rate increases, rates are expected to remain elevated for a while. Higher interest rates typically have a delayed negative impact on the economy and companies’ sales. The stock market is particularly vulnerable because it is already expensive, with the S&P 500 trading at approximately 18 times the expected EPS for its component companies over the next twelve months. This ratio has increased even as bond yields have risen, indicating the stock market’s current optimism towards earnings growth. Consequently, stocks could experience significant declines if analysts begin to lower EPS estimates.
In summary, Wall Street’s forecasts of corporate earnings are projected to decrease, potentially leading to a downturn in the stock market. While optimism has prevailed, recent data suggests a shift in sentiment. Both aggregate forecasts for earnings per share and the percentage of upward revisions have shown slight improvements, but historical patterns indicate that cuts to earnings forecasts become more prevalent during periods of prolonged economic growth. Early signs are already emerging, with downward revisions to earnings estimates for the third quarter. As interest rates rise, these cuts to forecasts may intensify, having a negative effect on the economy and corporate sales. This is especially concerning as the stock market is already trading at elevated levels.