Wall Street Profit Estimates Are Too Rosy, Putting Stocks at Risk, Analysts Warn

Trader David O'Day, center, works on the New York Stock Exchange trading floor on Jan. 20, 2022. Courtney Crow/New York Stock Exchange via AP

Corporate earnings forecasts are too optimistic, a growing chorus of analysts are warning, with the inevitable downgrades likely to put downside pressure on stocks and adding to concerns about a broader economic slowdown, inventory gluts, and weakening consumer spending intentions.

Soaring inflation has followed a long run of ultra-loose monetary settings and unprecedented fiscal stimulus, driving the Fed to tighten financial conditions. Sharp rate hikes—along with expectations of more to come—have fueled speculation of a hard landing for the U.S. economy, with growing recession fears sparking a selloff in risk assets.

But while U.S. stocks have fallen into a bear market, Wall Street analysts remain remarkably bullish on corporate earnings.

‘Like Deer in Headlights’

Bloomberg Intelligence data shows that analysts have raised their net profit margin estimates for S&P 500 companies for 2022 from 8.7 percent at the beginning of the year, to 10 percent last month, to 10.7 percent.

Some analysts say there’s a misalignment between the recent run of softer U.S. economic data and projections and the rosy earnings forecasts.

“Economists have begun to cut their top-down economic forecasts for GDP, and yet fundamental company analysts are sitting there like deer in headlights not knowing what to do with numbers,” Morgan Stanley Chief Investment Officer Lisa Shalett told Bloomberg TV on June 27.

“We just don’t see how we don’t get a recalibration here from the analysts that take the E in P/Es down,” she added, referring to price-to-earnings ratios for valuing companies, also known as the earnings multiple.

In a similar vein, Goldman Sachs strategists said in a June 27 note that equity markets are under-pricing the impact of a potential recession.

“While rotations within the equity market have signaled expectations of slowing growth, index valuation does not appear to be providing a buffer for the uncertainty around the path of future earnings,” Goldman Sachs strategists said in a June 27 note, per Bloomberg.

‘Worst Profit Recession in 50 Years’

Besides the potential that slowing economic growth will compress multiples, there’s also evidence that businesses have borne a significant portion of the inflationary surge rather than passing it on to customers, suggesting further pressure on profits.

Economist Stephanie Pomboy warned that major U.S. corporations face “the worst profit recession in 50 years,” explaining in a recent interview on the Wealthion program that a profit proxy gauge that measures the difference between business input costs and consumer prices has sunk to lows not seen in decades.

“In the last year, we’ve seen a gap between the two of those that implies the most acute margin squeeze since the 1970s,” she said.

“It’s not only forecasting a profit recession, it’s forecasting the worst profit recession in 50 years,” she added.

Inventory Glut

The rosy earnings forecasts are also set against climbing wholesale and retail inventories, raising the likelihood that businesses will have to slash prices to unclog inventory gluts, suffering hits to their bottom lines.

Businesses rushed to replenish inventories after they were depleted as the economy rebounded from pandemic disruptions. This has turned into an inventory overhang, however, with major firms like Target and Walmart recently warning that profits would take a short-term hit as they seek to clear the glut.

Recent government data shows inventory pressures continuing to build. The U.S. Census Bureau said in a June 28 report (pdf) that wholesale inventories jumped 2 percent month-over-month in May and 25 percent year-over-year, while retail inventories rose 1.1 percent month-over-month and 17.3 percent year-over-year.

Some analysts fear that slowing consumer demand could exacerbate the inventory glut, adding to the risk of a recession.

‘Risks for Consumer Spending’

While American consumers have been buoyed by massive savings and rising wages from a tight labor market, soaring inflation has pushed real wages into negative territory and eroded buying power.

“High inflation has hit real earnings, thereby posing risks for consumer spending,” Deloitte analysts wrote in the latest consumer tracker report, which noted more signs of “weakening financial sentiment.”

Not only has the closely-watched University of Michigan consumer sentiment gauge plunged to record lows, but the share of Americans worried about their level of savings has also nearly doubled over the past year, Deloitte analysts said.

“As sentiment about personal finances weakens, spending intentions are suffering,” they said while noting a drop in Americans’ discretionary spending plans, with the sharpest decline among middle-income consumers.

Discretionary or non-essential consumer spending is poised to take the brunt of the downturn in consumer sentiment, according to Pomboy, who predicted that companies in the consumer discretionary sector would be the “point of maximum pain” in the coming profit squeeze.

Pomboy said forecasts for profit growth in this sector remain at a “staggering” 24 percent for 2022 and 38 percent in 2023.

“Calling these forecasts pie in the sky is to demean it enormously,” she said. “Down 24% would be more like it,” she added.