In mid-October, the 3Q corporate earnings reporting season opens in the USA and in Europe. Expectations for S&P500 companies point to modest earnings growth, by around 2.5% y/y.
Analysts, in light of the slowdown of demand and of the further strengthening of the dollar, have sharply revised down their forecasts for the quarter in the US: after the slight revisions (by close to -1%) made in the opening two quarters of the year, earnings forecasts have been cut by 7% for S&P500 companies, marking the sharpest reduction since the beginning of 2019 (excluding the plunge that followed the onset of the pandemic). Vice versa, in the Eurozone, forecasts have actually been revised up, led by the energy sector.
Market performances in 3Q 2022
In 3Q, both the stock markets and bond markets incurred further losses. The high level of inflation and the reaction of the central banks were the reason behind the volatility on the markets.
In the opening weeks of the quarter, initial signals of an economic slowdown, and a weaker than expected inflation reading for July, prompted the markets to prematurely price in an easing of the Fed’s restrictive monetary policy, resulting in a widespread recovery of risk assets. However, the strong inflation reading for August, and the Fed’s statements reasserting its intention to press on expeditiously in hiking rates, pushed the markets down again, to just below the lows for this year marked at the end of June.
In Europe, additional tensions stem from energy crisis caused by the dragging on of the Russia-Ukraine war, whereas in China the stimulus injected into the economy is still undermined in part by the strict anti-Covid measures enforced by the authorities.
Unlike the opening two quarters of the year, however, energy prices dropped in the course of the summer months, sending an encouraging signal.
3Q earnings reporting season
In mid-October, the 3Q corporate earnings reporting season opens in the USA, and will reach its height at the end of the month (with results in Europe published roughly at the same time).
As regards the US stock market (S&P500), earnings are expected to show modest annual growth, by around 2.5% y/y (from 8.5% del 2Q), as opposed to a slight decline in quarterly terms.
In the past tree months, analysts have sharply revised down their corporate earnings forecasts for 3Q (by around 7%), more than the average cut in historical terms. At the same time, forecasts for 4Q 2022 were also revised down (albeit to a lesser extent, by -4.5%), implying a downside revision for 2022 as a whole.
Analysts usually cut their estimates in the run-up to the reporting season. The average revision has amounted to -2.3% in the past five years, and to -3.3% in the past 10 years.
Earnings have been revised down across sectors, with the sole exception of energy. The sectors most affected by the downside revisions were basic materials, discretionary consumer goods, e-commerce, and technology.
The strengthening of the dollar and the weakening of demand should result in a deceleration of revenues as well (consensus forecast: 8.5% y/y), albeit from high growth levels.
Opposite signals in the Eurozone, where earnings are forecast to rise at a good pace and to strengthen in 3Q. The main contribution to earnings growth will come from the energy sector, that holds significant weight in European indices. However, the estimates are also influenced by ongoing inflation growth and rising rates, that benefit the financial sector and weaken the euro.
In the past few quarters, the resilience of demand has been the main driver of earnings growth, as it has allowed businesses to transfer cost increase to final prices.
In the present phase, the macro slowdown (caused by high prices and rising inters rates), peak pricing power, and a still tight labour market, are adding to the risk of a further reduction of earnings forecasts in the coming quarters.
In the quarter, analysts started to revised down their forecasts not only for full-year 2022, but also for 2023 and 2024.
The fact that forecasts are starting to price the potential macroeconomic slowdown is encouraging. For the time being however, forecasts are not pricing in concerns either of a sharp decline in activity, or of a recessions.
Estimates in the US remain rather high, in fact, for 2023 (7%). The forecast slowdown is only slightly more evident in the emerging countries (to 4.7%) and in the Eurozone, where forecasts for the next year have been cut to 3.4%, as opposed to upside revisions for this year.
Appealing valuations in a medium-long term perspective
In the run up to the earnings reporting season, market valuations have fully corrected from their post-Covid highs, as a result of falling stock prices (that mechanically accompanied the rise in bond yields), while earnings continued to grow.
Absolute valuations are back at historically appealing levels: EuroStoxx and emerging market multiples have dropped to levels close to those recorded in previous crises, whereas S&P500 valuations are back at pre-Covid level, lose to their long-term averages.
The conservative adjustment of valuations should buffer the impact of the future earnings forecast cuts that will accompany the macro slowdown. However, market volatility will depend on the size of the slowdown. A soft-landing scenario, with stabilising rates and signs of an easing of inflation, would allow a swift recovery of the markets. Vice versa, a sharper slowdown would result in a stabilisation of bond rates, pushing back the recovery of stocks in waiting for further downside earnings revisions.