S&P 500 earnings forecast jumps but inflation and recession risks remain
It’s like we’re battling the mythical nine-headed hydra, but with three heads, one being inflation, two being recession, and the third being “how long can earnings estimates hold out?”
With May 2022 on Friday, it seems almost no one mentioned it was +0.3% versus the +0.4% expected.
Pressure on energy (i.e.) or food prices is unlikely to ease any time soon, but the other components are expected to start to gradually weaken (at least the Fed Governors keep telling us that). May is due out on Friday, June 10, before the opening bell and is expected at +0.7%, while it is expected to come in at +0.5%, down from +0.6% previous. Next week, June 15, is the next FOMC meeting and fed funds are expected to rise 50 basis points into the 1.50% range.
The 3,800 level held on the S&P 500 (in fact, 3,810 was the May 20th low) which is the key 1/3 retracement level for the S&P according to many good technicians.
Cautious comments on Apple (NASDAQ:) from Morgan Stanley’s Katy Huberty sent the stock down -3.8% on Friday, but it couldn’t even reach average volume. Here’s a quick look at BPA revisions and revenue estimates for Apple:
Revisions to Apple’s EPS estimate
Source: BIES data by Refinitiv
Apple revenue revisions
Note the revisions from 2022: they still look correct. Some of the other FAANG members look much worse. Not much damage here, though (yet).
S&P 500 data from TWIE and Earnings Dashboard: (IBES data from Refinitiv)
- The 4-quarter forward estimate rose to $235.17 last week from $233.49 the previous week.
- The PE ratio on the forward estimate was 17.5x versus 17.8x the previous week;
- The S&P earnings yield hit 5.72% from 5.62% the previous week;
Here’s a part of the earnings spreadsheet (see the spreadsheet above this sentence) that isn’t displayed too much: it’s the annual S&P EPS estimates with the quarterly bottom-up estimates.
Look at Q1 2022: Since April 1, 2022 or the near start of Q1 22 results, the bottom-up quarterly estimate has risen 6.5%, which is the normal or upper end of the typical “surprise” factor. The second quarter of 2022 has not moved at all. And that’s usually not the case until July 1, 2022.
We (readers/investors) are reverting to the typical normal pattern of S&P earnings estimates, and it will become even more so after the Q2 2022 earnings release, as this will be the last raw Covid distortion quarter we will see. In the second quarter of 2021, S&P EPS increased 96%, while S&P revenue increased 25%. Doubtful, we’ll see that compare for a while.
Watch credit spreads: Credit “risk” rallied sharply last week, alongside the S&P’s 6% gain. It was difficult to determine this year in the area of high-yield and high-quality corporate bonds to what extent the decline in prices was linked to duration and to what extent deterioration in credit was expected. With economic data holding up and S&P 500 earnings holding up, you have to assume that much of the deterioration in the price of these vehicles was interest rate related.
Bloomberg and investment grade corporate bond proxies started 2022 with durations above 9%. It was difficult to own this asset class for clients and we didn’t and took the credit risk in the short term high yield bond ETF and high yield and high yield municipal funds short term from Nuveen, but we sold all of that out by early April 2022.
In 2007, 2008, interest rates fell but credit spreads widened. In 2022, interest rates rise and credit spreads also widen.
Neither the LQD nor the Pimco ETF were able to recover their downward sloping 50-day moving average. They rebounded last week, with the average acting as resistance.
The 12 main holdings as of 05/31/22:
- Schwab Money Market Fund
- Blackrock Strategic Inc Fund: -3.70% YTD
- S&P 500 Equal Weight ETF (): YTD return -8.11%
- JP Morgan Income Fund: -4.62% return since the beginning of the year
- Microsoft (): -18.79% YTD return
- Oakmark International: -9.90% return since the beginning of the year
- Charles Schwab (): -16.17% return since the beginning of the year
- Tesla (): -28.25% yield since the start of the year
- JP Morgan (): -15.23% return since the beginning of the year
- Merck (): +21% return since the beginning of the year
- Pfizer (): -8.82% return since the start of the year
- Amazon (): -28% cumulative return since the beginning of the year
As of May 31, the was down -12.79% and the was down -8.74%. A balanced benchmark portfolio of 60% S&P 500 and 40% AGG was -11.17% lower year-to-date.
There is no doubt that the range of outcomes for returns of various asset classes for retail investors has increased significantly in 2022, but with the Fed/FOMC eyeing two back-to-back 50 basis point federal funds rate hikes. base on June 15, then again in July, customers are sitting on more cash than usual. With the risk of recession increasing, clients were advised that they would likely see more positions that would outperform under economic duress, with these ETFs or funds or securities being added after each rate hike.
As for how long the S&P will hold earnings, Apple was a good example today of what a downgrade can do to a stock in a tough band. EPS and earnings estimates are still seeing positive revisions and yet the stock is down 16% from its all-time high of $180.
There are few places to hide in this market, the dollar () being one, is flat at 2% higher in 2022 then the money/currency markets.
It has been difficult to diversify client accounts in 2022: as client accounts launched in 2022 had between 10% and 12% in the Oakmark International fund or in the (Emerging Markets ex-China ETF) and both are negative since the beginning of the year, with Oakmark International thanks mainly to Ukraine and its impact on Europe and the EMXC thanks to China’s problems around other emerging markets.
Value funds are even down over the year. Bill Nygren at Oakmark is a great value investor and as of 5/31/22 his fund was down -8.5% in 2022.
None of this is a recommendation or suggestion to buy or sell. Client holdings can change rapidly and past performance is no guarantee of future results. Capital market conditions can change quickly. Do your own homework and assess your own risk appetite in the face of financial market volatility.
Personally, I don’t think this is a repeat of 2001 – 2002 or 2007 – 2008 but the following events would be disturbing together or separately:
1. Trading up as high as 3.16%, May 9 high yield print;
2. Crude Oil has been trading all the way to the $130-$131 high since early March 2022;
3. The S&P 500 is trading and closing below 3,800 on heavy volume;