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Earnings Could Pull Stocks Down Despite Their Rise

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Although markets have enjoyed recent gains, some investors believe that weak earnings will cause stocks to decline once more.

U.S. stocks have recently experienced a turnaround on hopes that the Federal Reserve may decrease the rate of rate rises as early as December. That has been a pleasant change, since stocks have been under pressure all year due to raging inflation and the Fed’s aggressive rate-raising campaign in an effort to tamp down the price increases. Despite being down 16% for the year, the S&P 500 is up 13% from its lowest finish of 2022 on October 12.

According to investors, the current market exuberance may soon fade as corporate profits continue to be squeezed. The ratio of a company’s share price to its earnings is frequently used by market players to determine whether a stock looks to be cheap or expensive. If the profits component of the equation slows down, the market may appear to be expensive.

According to Sandi Bragar, chief client officer at asset management company Aspiriant, “the market just wants to keep moving up.” The fundamentals just don’t seem to be there, but it would be fantastic if they were. According to FactSet, index constituents are on track to report about 2% year-over-year profit increase for the third quarter with data from 97% of S&P 500 companies in. The earnings increase since the third quarter of 2020, at the height of the Covid-19 outbreak, has been the slowest. Companies like Salesforce Inc., Dollar General Corp., and Kroger Co. are among those scheduled to release their quarterly results this coming week. Investors will also analyze economic data, including the most recent reading of consumer confidence, an estimate of GDP, and the Labor Department’s monthly jobs report.

The current projection for the first annualized quarterly profits decrease since 2020 comes as a result of Wall Street analysts dramatically cutting their current-quarter earnings predictions for S&P 500 businesses. According to FactSet data, analysts predicted a 9% increase in earnings for the fourth quarter at the end of June; as of Friday, they expect a 2% decline.

Analysts continue to paint a positive future, with average projections calling for greater than 5% annualized profit growth in 2023. But when a potential recession looms and the Fed’s rate rises start to affect corporations’ bottom lines, many investors expect further downward revisions.

According to Benjamin Kirby, co-head of investments and portfolio manager at Thornburg Investment Management, “estimates are much too high moving into 2023.” When a stricter monetary policy affects actual firm earnings, there is a lag.

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The U.S. economy will experience a recession, according to Mr. Kirby, who also stated that his company is generally setting portfolios defensively by holding some cash and stocks of companies with lower valuation multiples. He believes that businesses in the telecoms sector should keep making money even when the economy is slowing down. Stocks appear more affordable than they did for the majority of the previous two years, but values are rising once more as the market gains momentum. According to FactSet, the S&P 500 companies are trading at a premium of almost 17 times expected future earnings. That is a decrease from the more than 21 times at the beginning of 2022, but an increase from the 15 or so at the year’s lows and a little bit above the 10-year average.

Stocks appear to be significantly more expensive on a forward-looking basis for investors who think earnings projections have more potential to decline in 2023.

According to Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services, 2023 earnings predictions are now too optimistic, so if they are revised lower, “we’re expecting a bearish move in the S&P 500.” Because the optimism premium is factored into the expectations for the next four quarters, stocks are still pricey.

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