Concerns are escalating that U.S. corporate earnings are progressively at risk from dizzying inflation, increasing interest rates, and a strong dollar, upsetting the outlook for investors already stumbling from the S&P 500’s bear market confirmation earlier this week.
While second-quarter profit growth estimates have dropped in recent weeks, forecasts for the third and fourth quarters and for all of 2022 have kept up or mounted, according to IBES data from Refinitiv. As of June 17, Wall Street analysts predicted S&P 500 earnings to jump by 9.6% this year, up compared to 8.8% at the beginning of April and 8.4% on January 1.
Strategists fear those forecasts are unlikely to keep up. Many anticipate more negative outlooks from U.S. companies in the weeks to come and said that guidance will be displayed in consensus profit growth estimates.
Many S&P 500 companies will disclose second-quarter earnings after mid-July, and retailer Target (TGT.N) and software giant Microsoft (MSFT.O) have been among the companies issuing gloomy outlooks in recent weeks.
Peter Tuz, president of Chase Investment Counsel, stated:
“Estimates are too high, and you’ll see them start to come down as the second-quarter numbers come out and as companies talk about what they’re seeing.”
Disappointing profit expectations could mean more trouble for a market that has been struck by worries over how a hawkish Federal Reserve response to soaring inflation could hurt growth.
The S&P 500 (.SPX) ended Monday more than 20% under its record closing high establishing the index is in a bear market, according to an often-used definition. The fall followed higher-than-expected inflation data last week that boosted expectations for how much the Fed will need to tighten monetary policy so as to control consumer prices.
The Fed on Wednesday hiked rates by 75 basis points, its largest increase since 1994, and has now raised borrowing costs by a total of 150 basis points in 2022.
Worries that corporate profits are reeling could support the argument that stocks remain highly valued despite their steep slump this year. The &P 500’s forward 12-month price-to-earnings ratio reached 17.1 as of Friday compared to 22.1 at the end of December but was still higher than its long-term average of about 16, according to Refinitiv data.
Challenges encountered by .S. companies include a stronger dollar, which was mentioned by Microsoft when the software-maker reduced its fourth-quarter estimate for profit and revenue earlier in June. A strong dollar usually drains the profits of companies that have international operations and swap foreign currencies for dollars.
The U.S. currency has gained about 9% so far this year and is near a two-decade high against a basket of its peers, propelled by expectations of growing U.S. rates and enhanced geopolitical tensions.
Various Factors Affect Company Profits
After Microsoft’s announcement, investors will be paying attention to what other software and tech companies like IBM(IBM.N) and Adobe Inc (ADBE.O) have to say about their currency issues in future reports, Daniel Morgan, portfolio manager at Synovus Trust. Adobe is expected to post second-quarter results after the bell Thursday.
Also carefully watched will be retailers and other consumer discretionary companies, which have strained under the effects of soaring inflation. Walmart (WMT.N) shares and those of other big retailers suffered losses last week after Target reduced its quarterly profit margin estimate and said it would have to give bigger discounts to clear inventory.
Other challenges include steep oil prices and hiking interest rates, which have eroded tech and growth stocks, whose valuations heavily depend on future cash flows. Recent COVID-related lockdowns in China could also have had a bad effect.
BlackRock analysts wrote in a recent note on why they are not “buying the dip” in stocks:
“We expect the energy crunch to hit growth and higher labor costs to eat into profits. The problem: Consensus earnings estimates don’t appear to reflect this.”
To be sure, while consumer spending is “shifting,” it does not appear to be slowing, said Steve DeSanctis, small- and mid-capitalization equity strategist at Jefferies. That may imply some retailers could profit from changing consumer habits, even as others face hard times.
At the same time, investors may already be pricing in gradual hits to earnings given stocks’ recent fall, said Kristina Hooper, chief global market strategist at Invesco.
“The question becomes whether it comes so fast and furious that it really shakes market confidence even further.”