There is a loss of earnings. This is bad news for stocks.


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Trading floor at the New York Stock Exchange on Tuesday.

David L. Nemec / New York Stock Exchange

There are increasing signs that Wall Street will have to lower its sales forecasts. This could easily drag the stock market even further than it has already fallen.

The current consensus on earnings prospects is overly optimistic. According to FactSet, consensus forecasts for aggregate corporate earnings in the S&P 500 are up a little over 2% over the past six months for both this year and 2023. However, these modest gains came even as inflation remained higher than expected, prompting the Federal Reserve to make clear it will aggressively raise interest rates in response.

The fear of a recession is growing. And analysts can’t figure out just how much revenue hurt was caused by the weakening economy and rising prices and borrowing costs. All they needed to continue extrapolating future earnings were quarterly sales reports, a set of better-than-expected numbers.

As the relatively good times behind these numbers are unlikely to last, earnings expectations are likely to fall.

“Estimates have come down,” said Rhys Williams, chief investment officer at Spouting Rock Asset Management.

These potential earnings forecast cuts could be more than just a clue. During the average recession, Wall Street consensus on aggregate earnings per share over the next 12 months for S&P 500 companies fell about 15%, according to Morgan Stanley. Street currently expects a total gain of $239, so such a drop would bring the number down to around $206.

If the S&P 500 continued to trade at the current forward earnings multiple, the index would fall by the same percentage — just under 3,200 from the current 3,783. Other views are even darker.

According to Evercore, actual returns have historically tended to fall 15% annually during the recession. That means total earnings per share for the S&P 500 could fall to about $192 in 2023, from $227 expected this year. Maintaining the index’s current multiple would see the index fall to around 3,000 by the end of this year.

Those potential declines don’t include the possibility that valuations could fall from there. The S&P 500 is now trading at about 15.8 times next year’s expected earnings, but many note it could fall slightly.

Morgan Stanley chief strategist Mike Wilson wrote on Monday it could go as high as 14 times. Although that multiple fell from a 21x at the start of the year, long-term bond yields rose. This reduces the current discounted value of future profits, meaning the valuation is less than 15x.

Morgan Stanley notes that if Wall Street hits $190 in the mid-$190 range for the S&P 500 index by 2023 and the index trades 14 times, the index would fall below 3,000.

It’s far from clear that all of these declines will happen, but it’s possible. Consider it another red flag for anyone looking to shop at the current level.

Email Jacob Sonenshine at [email protected]



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