EPS could come down by 40% over the next couple of years, dragging markets 20 to 30%: Strategist
A dimming earnings outlook is at odds with the recent rebound in stock markets, according to strategists at Morgan Stanley and Goldman Sachs Group Inc.
Both Morgan Stanley’s Michael J. Wilson and Goldman’s David J. Kostin expect corporate profit margins to contract next year given unrelenting cost pressures, they wrote in separate notes. According to Wilson, who has been one of the most vocal bears on US stocks, “the best part of the rally is over.”
The forecasts come on the heels of a better-than-feared second-quarter earnings season, which sparked a sharp rally in US stocks last month as investors bet that margins could withstand inflationary pressure. Optimism around a dovish tilt in Federal Reserve policy amid weaker economic data has also lifted sentiment.
Yet the strategists aren’t so sure. “While prices to the end consumer are still rising at a rapid clip, prices for producers are rising at double the pace,” Morgan Stanley’s Wilson wrote in a note dated Aug. 8. Analyst expectations of margins expanding into 2023 are “unrealistic due to sticky cost pressures and receding demand.”
Goldman’s Kostin concurs, saying higher input costs will dent profit margins next year even as revenues continue to rise, albeit at a slower pace. The strategist now expects net margins to fall by 25 basis points in 2023, seeing contraction in every sector, led by materials, energy and health care.
'BEAR MARKET RALLY'
Morgan Stanley’s Wilson, who correctly predicted this year’s selloff, is skeptical of the recent rebound, having called it a “bear market rally” amid growing fears of a recession. While he believes inflation has peaked and “will probably fall faster than the market currently expects,” that still doesn’t bode well for stock markets as it’ll reduce operating leverage and weigh on company earnings, he said.
“We think it’s premature to sound the all-clear simply because inflation has peaked,” Wilson said. “The next leg lower may have to wait until September when our negative operating leverage thesis is more reflected in earnings estimates.”
Bank of America Corp. strategists have also said they expect the S&P 500 Index to trade in a range of 3,800 to 4,200 until the Fed’s next meeting in September. By contrast, JPMorgan Chase & Co. strategists remain among the few bullish voices on US equities among top forecasters. They reiterated in a note on Monday that the risk-reward is “not all bad” as they continue to see weaker data leading to a policy pivot by the Fed.