The economy is officially expected to slip into recession in 2023 as the US Federal Reserve (Fed) raises interest rates. In such an environment, lower consumer demand and higher borrowing costs will drive down corporate profits. Lower earnings forecasts across the sector for 2022 are reflected in the decline in the stock market. Most companies are declining in value, but changing dynamics in 2023 could change the landscape for US stocks. The battle between profit and price causes market volatility.
“The trajectory of the S&P 500 in 2023 will be a case of contracting earnings and expanding valuations as the risk of recession looms in the US,” said Dylan Cheang, a strategist at DBS Bank. 40′ of.The following is an excerpt from the report.
For the fourth quarter of 2022 (as of Nov. 22), Street revised its U.S. earnings forecast by 1.2%. The sectors that saw the biggest downward revisions included financials (-6.2%), materials (-6.4%) and consumer goods (-6.4%). -4.3%).
Despite the downgrade, there is too much optimism in the market today. Earnings growth of 7% is expected on a full-year basis in 2023, despite heightened risks of recession.
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As our analysis shows, US earnings have historically declined by an average of 10% in a “mild” recession.
The apparent gap between analyst forecasts and actual economic reality can be attributed to two factors:
- The Fed has embarked on aggressive monetary tightening, but its impact has not yet been fully transmitted across the economy, leaving an element of ‘cautious optimism’ in the market.
- Equity analysts are awaiting further confirmation on the economic outlook and guidance from company management before cutting earnings. The fourth quarter 2022 reporting season will reveal more details about how the Fed’s tightening has impacted corporate earnings.
More in the first half of 2023, as analysts start pricing in the possibility of a weakening top line (as a result of a “soft” recession) and shrinking margins (as a result of lingering inflationary pressures). Earnings downgrades are expected. yearly.
Also Read: Fed Minutes Reveal No Rate Cuts in 2023, Economy Heads for Recession
Downward earnings revisions are expected to gain momentum as the US economic outlook becomes more clear in the coming months. Ultimately, the S&P 500’s trajectory will be subject to the intersection of shrinking earnings and rising valuations in 2023.
Below are the key assumptions.
• A dovish turn from the Fed as the US economy slows. Lower bond yields, and thus lower risk-free rates, lead to higher valuations.
• Assuming forward P/E returns to its five-year average, this equates to an average valuation expansion of 8% in the US (roughly equal to the 7% average expansion seen in the ‘softer’ period). Is the same). recession).
• Sector earnings growth is currently averaging 8%, which is overly optimistic. Assuming a 10% historical average decline in earnings today due to the recession, the decline in earnings is nearly offset by the widening valuations.
