Worrying signs are already appearing in earnings season - Morgan Stanley

Apr. 18, 2022 8:19 AM ETSPDR S&P 500 Trust ETF (SPY)SP500, XLY, XLI, XLK, SOXX, SMH, XLE, XLB, IYT, CARZ, XRT, XLP, PBJ, XLV, XLF, KBE, IAK, XSW, XLC, IYZ, XLU, XLREBy: Kim Khan, SA News Editor72 Comments

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Signs are emerging that Q1 earnings season will be more disappointing than expected, especially with regards to forward estimates and guidance, Morgan Stanley says.

"Earnings revisions breadth for the S&P 500 (SP500) (NYSEARCA:SPY) has resumed its downtrend over the past 2 weeks and is once again approaching negative territory (which would mean more downward than upward out-year EPS revisions)," chief equity strategist Mike Wilson wrote in a note Monday.

"This is largely being driven by declining revisions in cyclical industries where we've been more negative - Consumer (XLY), Industrials (XLI), Tech Hardware (XLK) and Semis (SOXX) (SMH)," Wilson said. "Negative revisions are often an indication that forward EPS estimates are going to flatten out or even fall."

With cost pressures, payback risk in consumer demand and the Russia/Ukraine war, a "downward move in revisions should play out again into 1Q reporting season," he added.

"The difference this time is that we think the downtrend is likely to take revisions breadth outright negative, and potentially well into negative territory. While this is no guarantee of a collapse of forward EPS, it is typically a sign that forward earnings estimates are going to decelerate or at least consolidate sideway."

Inflation now an earnings headwind

The positive effects of inflation on earnings have reached their peak and will now be a headwind to growth, especially with a hawkish Fed, Wilson said.

The "de-rating has been most severe in the expensive and/or economically sensitive areas of the market while defensive areas have actually seen multiples expand," he noted. "This suggests the market is worrying about higher rates and slower growth even as the overall index remains expensive."

That's classic late cycle, according to Wilson.

The forward P/E for the S&P 500 has dropped 11% from November 15, 2021 to April 13.

In comparison by sector:

  • Energy (XLE) -7%
  • Materials (XLB) -7%
  • Industrials (XLI): capital goods -10%, commercial and professional services -12%, transportation (IYT) -19%
  • Consumer Discretionary (XLY): autos and components (CARZ) -18%, consumer durables and apparel -29%, consumer services -38%, retailing (XRT) -18%
  • Consumer Staples (XLP): food and staples retail +4%, food beverage and tobacco (PBJ) +10%, household and personal products +2%
  • Healthcare (XLV): HC equipment and services 0%, pharma, biotech and life sciences -2%
  • Financials (XLF): banks (KBE) -17%, diversified financials -5%, insurance (IAK) +7%
  • Tech (XLK): semis and semi equipment (SOXX) (SMH) -28%, software and services (XSW) -20%, tech hardware and equipment 0%
  • Communication Services (XLC): communication services -19%, media & entertainment -23%, telecom (IYZ) +8%
  • Utilities (XLU) +12%
  • Real Estate (XLRE) -4%

Goldman Sachs said there is now a 35% chance of a U.S. recession over the next two years.

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