The earnings depression is about to begin

First quarter earnings season will pick up this week with several major banks announcing results on Friday.

And when that earnings period largely ends by Memorial Day, analysts expect an obvious quickie – American companies are in an earnings slump.

After earnings per share for S&P 500 companies fell 4.6% in the fourth quarter of 2022, earnings are expected to decline 6.8% year-on-year in the first quarter of 2023, According to data from FactSet.

“Analysts and companies were more pessimistic on their first-quarter earnings forecasts than historical averages,” John Butters of FactSet wrote in a note.

“As a result, estimated earnings for the S&P 500 for the first quarter are lower today compared to expectations at the start of the quarter. The index is now expected to post the largest annual decline in earnings since the second quarter of 2020.”

With earnings down two consecutive quarters year over year, this is sending the earnings of the market’s largest companies into recession.

By definition, arguments among investors about what is “priced” in the market cannot be settled. This is what the market is for, after all.

Whether this earnings slump confirms the obvious or acts as new information is a matter we’ll leave investors to sort out. But market behavior in the past year which saw the S&P 500 suffer its biggest decline since 2008 indicates that investors were preparing for corporate results like those are feeding now and what might come in the coming quarters.

During the first quarter, analysts cut expected earnings-per-share growth by 6.2%. Over the past decade, the average quarter-quarter decline in earnings expectations has been 3.3%.

And the news isn’t expected to improve much in the second quarter, with FactSet noting that the forecast for the second quarter is that S&P 500 earnings will fall another 4.6% from a year earlier. Earnings are expected to return to growth in the third quarter.

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With recent data from the manufacturing sector, the services sector, and the US labor market pointing to an imminent downturn in the economy, this downturn in the corporate world doesn’t come as a complete surprise.

After all, investors have been wary of a seemingly imminent recession in the US for most of the past year as soaring inflation and skyrocketing interest rates generated warning signs of lower growth ahead.

But some strategists don’t think the market is done pricing in bleaker earnings expectations. He expects investors will eventually heed the warnings from corporate earnings.

“Investors may be eyeing an earnings contraction in 2023 to a strong rebound next year, mainly in an effort to drive peak multiples on rock bottom earnings,” Barclays strategist Venu Krishna wrote in a note to clients Monday.

“However, we are confident of that [next twelve months] EPS pieces are far from finished; Consensus estimates are consistently overly optimistic even after a few months, and a potential recession only increases the degree to which forward estimates overestimate actual earnings.”

Noting FactSet’s work, earnings estimates for first-quarter earnings fell sharply while estimates for the full year remained relatively flat.

Investors are still expecting the S&P 500 to gain $219 per share in 2023; Barclays expects full-year earnings to be close to $200 per share.

Ultimately, we believe that the market is still pricing in a “no-down” scenario: a scenario in which the Fed moderates inflation (perhaps at a level somewhat above its 2% target), while economic growth avoids a recession and eventually rebounds strongly in the future. year 2024″.

“This is the outcome that best supports the current consensus, and we don’t see it very well. Our base case is still a shallow recession this year, and if the history of recessionary bear markets (particularly high-inflationary markets) is a guide, both sides of the price multiplier remain to profit are subject to disproportionate downside risk.

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