Join us for Forward’s Q3 Outlook Call on Thursday, 6/30 at 1:00 EST. Register HERE
Rising rates have dragged down bond prices 10% so far this year while US equities are down 20%. Speculative parts of the market have lost as much as 75%. Total losses add up to $15.5tn, about 60% of US GDP, according to BCA Research. Q2 earnings season, starting in July, will provide key fundamental data on the health of corporations and their outlook for the remainder of 2022.
On the economic front, inflation has been the biggest domestic headline so far this year. It persisted through the spring and has yet to plateau and offer hope of heading lower. Consumer prices were up 8.6% YoY in May, the highest monthly reading in over 40 years. The Fed raised rates in March (+0.25%), May (+0.50%) and June (+0.75%), bringing Fed Funds to 1.50%. Market expectations for at least an additional +1.50% by year end are greater than an 80% probability, according to the CME’s FedWatch Tool (see chart below, data as of 6/23). The Fed was slow to act and had a misunderstanding of the inflation dynamics at play, but now admit they will intentionally hike to slow growth and constrain inflation.
Consumer confidence is low, and angst about the future is high. There have been calls for a coming recession alongside adamant defenses that the economy is buoyed by household savings and a vibrant jobs market. With Bank of America’s Bull & Bear Indicator survey registering 0.0 (below) - its lowest possible reading, markets may be poised for some short-term relief. But what comes after that? Hence the emphasis on Q2 earnings in this note.
Earnings estimates for the broad market for 2022 and 2023 have risen this year (See Factset Chart below, with author’s notations). The adjustment to market prices has taken place through the P/E multiple falling (investors demanding a higher risk premium). Thus, the current message here from the stock market is that investors have roughly adjusted to higher interest rates and levels of inflation, however, they have not adjusted expectations for the level of corporate profitability.
A closer look at earnings by sector shows a more nuanced picture. While estimates for the current quarter have broadly held steady over recent months, when removing the energy sector’s positive impact, estimates for the remainder of the index actually fell -4.3%. Mr. BlondeMacro recently pointed out that this loss of momentum is already apparent for full year 2022 earnings:
In FWM’s Q2 Outlook, a scenario approach to SPX fair value was outlined. A downside scenario assessed the implications of both a lower P/E (13.5x) accompanied with *slightly* lower earnings of $225, producing a S&P value of 3,038. This looks like the most likely outcome by year-end. So, while the current predominant market narrative centers around rate hikes to quell inflation, the next public discussion will likely center around cuts to growth—both in the form of economic output and earnings—and what options policy makers have to do something about it.
Join us for Forward’s Q3 Outlook Call on Thursday, 6/30 at 1:00 EST. Register HERE