Is the Budding Bull Market Real?

The bull has sentiment in its favor, but what about earnings? … the challenge with an “all clear” forecast … how bears could be wrong


If recent bullishness is going to take root and turn into long-term, sustained bullishness, one of two things (or both) needs to happen:

  • Corporate earnings must rise
  • The multiple investors are willing to spend for those earnings must increase. We can also think of this multiple as “sentiment”

Now, sentiment can be incredibly powerful. It can (and often does) cause prices to soar and plummet to exaggerated levels that don’t reflect the true condition of underlying fundamentals.But eventually, when the disconnect between sentiment and earnings grows too great, something gives. Either earnings or sentiment will have to change to resolve the tension.In recent weeks, sentiment has staged a strong rebound.The pervasive bearishness from earlier in the year has weakened as bulls eye reduced rate hikes at the December Fed meeting, strong historical average returns in the year following a 20%+ loss, and the assumption that inflation has peaked and is on its way out.The impact of this invigorated sentiment is that CNN’s Fear & Green Index shows that, rather than fear, we’re now at “Greed.” In fact, we’re fast approaching “Extreme Greed.”

Graphic showing the primary emotion driving the market today is Greed
Source: CNN Fear & Greed Index

Score one for higher stock prices to come.But upcoming earnings could provide a big speedbump.

Per usual, Wall Street analysts have been slow to lower their earnings estimates

To unpack this, let’s begin with Barron’s:

Historically, next-year S&P 500 EPS expectations drop about 10% on average in the second half of a calendar year. However, earnings estimates have not fallen that much yet.In addition, this year Wall Street is worried about a recession, so 2023 EPS estimates could drop even more than usual.

Well, just this morning, The Wall Street Journal reported that analysts have finally begun to lower their earnings estimates, at least for Q4 that is.From the WSJ:

Wall Street analysts have also sharply marked down current-quarter earnings estimates for S&P 500 companies, now projecting the first annualized quarterly earnings decline since 2020.Analysts at the end of June saw profit growing roughly 9% in the fourth quarter; they see a contraction of around 2% as of Friday, FactSet figures show.

But looking at 2023, many analysts remain stubborn in their unwillingness to revise earnings estimates lower. Consensus estimates call for 5% earnings growth in 2023.Let’s now jump to MarketWatch:

…Anyone hoping for earnings growth even managing to be flat for 2023 “is very naïve”, according to Peter Ganry, head of equity strategy at Saxo Bank.Ganry notes that the 12-month forward earnings per share estimate on the S&P 500 is currently at $235.34 which is 7% above the expected full-year 2022 EPS of $219.38. That’s too high, he reckons.“There is nothing unusual in this divergence conflicting with reality as sell-side analysts have a natural long bias…and are slow to react and incorporate new information.“The fact that the 12-month forward EPS estimate on S&P 500 is only 4% from its recent peak despite the ongoing margin compression says it all.”

What does logic tell us about earnings?

Regular Digest readers know that we take “expert” earnings forecast with a big grain of salt because they’re often way off the mark.Given this, we shouldn’t assume that Ganry, who we just highlighted, is more correct than his bullish counterparts. So, let’s examine this more closely.Corporate layoffs, especially in tech, are accelerating.HP is the latest to drop the hammer. Last Wednesday, we learned it will be cutting between 4,000 to 6,000 jobs by the end of 2025.Before HP is was Twitter, Meta, Lyft, Stripe, Coinbase, Shopify, Netflix, Microsoft, Snap, Robinhood, Chime, Tesla… we could go on. Last week, analyst Genevieve Roch-Decter reported that here in 2022, 853 tech companies have laid off 137,492 people.  Overall, we’re seeing corporate managers lay off employees because either: 1) their profits are already down, requiring expense-cuts to maintain sufficient profitability or 2) they don’t like 2023’s economic forecast, so they’re “battening down the hatches,” as Jeff Bezos suggested should be doing.Either way, not great.Meanwhile, what do we know about U.S. consumers?Well, we’ve profiled them regularly here in the Digest.In short, they’re running low on savings, having trouble making financial ends meet with disposable income, and they’re increasingly turning to credit card spending at astronomical interest rates.Plus, as we’ve profiled in the Digest, we’ve actually been losing hundreds of thousands of full-time jobs since March, replacing them with part-time employment.Again, not great.

Most importantly, the current status of corporate layoffs and the U.S. consumer reflect the Fed’s interest rate hikes from six-to-nine months ago

Studies show there’s generally a six-to-nine-month lag time in between a rate-hike and when the economy fully feels it. So, today’s economic climate is like a time-capsule, reflecting what the Fed did months ago.Now, how many rate-hikes have happened in between six-to-nine months ago and today?Let’s make it easy and say “lots.”So…With corporate earnings and the U.S. consumer feeling increasingly pinched – based on the Fed’s actions from six-to-nine-months ago…And with lots of rate-hikes in the pipeline – and their full impact ahead of us thanks to lag time…Should corporate earnings and the U.S. consumer be in better or worse shape for at least the first half of 2023, compared to today?I’m not sure how anyone would answer “better.”But “better” is what many analysts are factoring into their earnings projections. As we just saw, analysts are calling for between 5% and 7% earnings growth next year above where 2022’s earnings are expected to come in.While falling inflation and the Fed’s impending rate-size-cut have the full attention of the bulls, shouldn’t this earnings situation get more attention? After all, sentiment can win many battles, but earnings eventually win the war.

So, let’s poke holes – how are we being overly gloomy and missing the boat?

First, here’s the starting bear case:Corporate earnings and the U.S. consumer will be deteriorating in the first half of 2023…potentially as sentiment-driven bulls inflate stock prices.If heightened bullishness runs into the reality check of bad earnings and poor household balance sheets in Q1/Q2 of next year, it will pop the sentiment balloon.Despondent sentiment plus disappointing earnings would be a toxic mix for portfolio returns. That could mean another 25% – 35% down as the market readjusts.(We’ll ignore the uber-bearish forecast out there that’s calling for a decade of lost returns.)Now, let’s look at three bullish scenarios…First, earnings could surprise us and come in far more robust than we expect in the next two quarters.While that’s possible, it is less likely based on the dynamic we just covered. If there is to be an earnings recovery in 2023, it would be in the back half of 2023, if at all, and would be based on falling inflation taking pressure off margins. But that will take a while to filter through the economy.The second, more likely bullish scenario is that if, come early/mid-2023, the data show inflation is dropping consistently, earnings are no longer falling (hopefully climbing), and retail/consumer forecasts have a hint of optimism – then Wall Street will forgive itself for stock prices that are too high relative to the poorer condition of earnings and consumer health.In that case, Wall Street will happily overlook the bad stuff since it knows sunnier days are coming with better fundamentals.Remember, Wall Street always looks ahead. So, compared to the broader economy, Wall Street suffers bad times first, yet catapults into recovery-mode first.Here’s a chart showing this interplay. It shows that stocks generally begin rising roughly four-to-six months before the economy hits its low-mark.

Chart showing the cyclical interplay between stocks and the economy as they rise and fall
Source: Capital Group, Federal Reserve data, Haver Analytics, National Bureau of Economic Research, Standard & Poor's

This hypothetical isn’t so much that the bearish scenario is “wrong” as much as it will be forgiven if there’s enough genuine positive forward-looking data.

Third and finally, there’s the one massive bullish trump card…

The Fed.If hawkishness from the Fed has just been smoke and mirrors… if we’re on the cusp of not only a reduction in the size of hikes, but a pause, or even a rate-cut (despite what Fed members say), then this bear market is over, even if there’s pain to come for the economy.Alternatively, if the Fed’s rate-hikes inadvertently break something in the economy in early 2023, forcing a sudden pivot of rate-cuts and/or liquidity, the bear market is over, even if the economy is hurting.But the downside of this Fed pivot is the potential for a surge in inflation.After all, if everyone becomes so giddy in the wake of a Fed pivot that a tidal wave of dollars floods the investment market, housing markets, and broader economy, that’s fuel for inflation. Not what the Fed wants.So, where does this leave us?For now, we’ll keep our bearish tilt as we look forward through the middle of next year. The bull case seems laser-focused on the Fed. But as we see it, even if the Fed pauses soon, upcoming lower earnings are already baked into the cake, which market prices are ignoring. The related questions are “how big a hit to earnings?” and “how forgiving will investors/Wall Street be?”We’ll see.By the way, to track the Fed, my colleague and fellow-Digest writer, Luis Hernandez recently put on your radar three huge dates for clues about Fed direction:

  • Jobs for November 12/2
  • CPI for November 12/13
  • Federal Reserve Meeting 12/13 to 12/14

We’ll keep you updated.Have a good evening,Jeff Remsburg

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