Earnings, Equities Stall speed—S&P 500 EPS preview

The earnings deluge begins
It’s that time of year again. Corporate America begins reporting 4Q results this week. We think the trends will be somewhat similar to recent quarters with a continued deceleration in earnings and revenue growth. In fact, the earnings headwinds have become strong enough that we are expecting essentially no growth in S&P 500 EPS compared to the prior year. In other words, earnings growth has reached stall speed. Our estimate reflects earnings beats of about 3%.

The headwinds should be well known—aggressive Fed rate increases to slow the economy and reduce inflation, a normalization in demand for products and services (especially tech) that were popular in the early days of the recovery from the pandemic, a strong dollar versus last year, and still higher than average cost increases (mostly for labor). Many of these headwinds are reflected in the generally cautious business sentiment readings for both manufacturing and services-oriented companies.

But there are also some positives. Consumer spending is being supported by continued job gains and nearly USD 1 trillion of savings that was accumulated during the pandemic. Furthermore, China reopening could boost commodity prices (good for energy and materials companies) and some US multinationals. But bear in mind that S&P 500 companies derive only 7% of revenues from China. In addition, the outlook for Europe looks a bit better due to the fall in energy prices—largely a result of the warm winter. Furthermore, the dollar may have peaked and non-labor cost increases are moderating as supply chain bottlenecks ease.

Putting it all together, we expect a sharp slowdown in revenue growth to the 4-5% range and a continued normalization in profit margins from higher than average levels last year.

Our EPS estimate suggests flat earnings versus the year ago period. But this masks some pretty wide divergences by sector and the fact that only three sectors look poised to produce earnings growth in the quarter. Excluding the energy sector, EPS will likely decline by 4.5%.

Our estimate reflects a 3% earnings beat relative to the bottom-up consensus estimate. While it may sound surprising to expect earnings to come in better than consensus expectations, bear in mind that management teams typically offer conservative guidance in order to beat the estimate when they report their results. In fact, the early reporters (companies whose fiscal quarters ended in November) are beating estimates by about 4% on average.

As always, management team guidance will be important. We expect guidance for 1Q23 to be somewhat mixed but generally tepid. But to be clear, we are not expecting an outright cautious tone. Continued job gains are supporting consumer spending, especially on services. But areas like enterprise tech spending, housing, and goods consumption could be somewhat soft. So far, analysts have trimmed their 1Q23 estimate by about 2.5% for the early reporters.

Retain defensive bias with a preference for value
Within US equities, we believe a defensive bias remains appropriate. We have most preferred views on consumer staples and healthcare. We also like the energy sector which should benefit from China reopening, structurally tight oil markets, and an attractive free cash flow yield.

We continue to favor value over growth. Despite outperforming, value still trades cheaper than normal versus growth. Higher than average inflation and supportive earnings trends also favor value.

Main contributors: David Lefkowitz, Nadia Lovell, and Matthew Tormey

Read the full report Stall speed—S&P 500 EPS preview 12 January 2023.

This content is a product of the UBS Chief Investment Office.