Wall Street analysts’ predictions for corporate earnings are likely to decline, which will impact the stock market in a negative way. While analysts have been optimistic about profits, there has been a shift in sentiment. One way to gauge this optimism is by looking at the aggregate 2023 earnings per share forecasts for companies in the S&P 500, which have increased by about 1.4% in the past six months. However, sales estimates have only risen slightly, and estimates for profit margins have also increased slightly due to a moderation in the pressure on companies’ bottom lines. Additionally, there has been an increase in upward revisions to forecasts for 2023 and 2024 EPS for companies in the S&P 500, indicating growing positivity. However, historically, during times when the economy has been growing for a few years and concerns about a potential slowdown have arisen, the number of upward revisions tends not to go much higher than 60% or 70%.
Despite the recent optimism, signs are emerging that earnings estimates have reached their peak. Forecasts for EPS have risen in the past six months but have declined in the past few weeks. DataTrek Research reported that estimates for aggregate third-quarter EPS for companies in the S&P 500 dropped by about 0.4% to $57.85 last week. Further cuts are expected as analysts set their final Q3 estimates. The potential for more downward revisions is heightened by the possibility of a weakening economy due to higher interest rates. While the Federal Reserve may be close to ending its interest-rate increases, rates are expected to remain elevated for a while. This could negatively impact the economy and companies’ sales.
These projections are particularly significant because the stock market is already expensive, with the S&P 500 trading at about 18 times the EPS its component companies are expected to produce over the next twelve months. The fact that this ratio has increased despite rising bond yields, which should dampen investors’ willingness to pay for future profits, suggests that the stock market is currently optimistic about earnings growth. However, if analysts cut EPS estimates, stocks could experience significant declines. Investors should be cautious in this market.