Why stock-market bulls are ‘woefully myopic’ about S&P 500 profit growth — even before the impact of a potential recession

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Wall Street forecasts for the S&P 500 to see single-digit profit growth in 2023-24 seem “woefully myopic,” with the U.S. stock-market benchmark’s historically high operating margins being a “material risk,” according to Morgan Stanley’s wealth-management division. 

“We worry that the bulls fail to analyze the current situation in a historical context,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, in a note Monday. “Yes, margins have begun to come down from their 2021 peak, but that doesn’t mean that they are not vulnerable to aggressive monetary tightening.”

Operating margins for companies in the S&P 500 index remain “rich,” according to the note. “Even before we consider the potential impact of recession,” said Shalett, “mean reversion could yield earnings disappointments.”

On a trailing four-quarter basis, S&P 500 operating margins are above their rolling 10-year average, a chart in her note shows.  


“On a four-quarter basis, S&P 500 operating margin, at 11.6%, is still near its 13.1% all-time high,” she wrote. “It also remains above the prepandemic 10.2% and the 9.4% rolling 10-year average.”

Inflation and corporate pricing power have “distorted” operating margins, Shalett warned. 

The Federal Reserve has been tightening its monetary policy in an effort to tame high inflation, with San Francisco Fed President Mary Daly saying Monday during a streamed interview with The Wall Street Journal that she expects the central bank to raise interest rates above 5% in order to bring down the cost of living in the U.S.

Read: Fed’s Daly sees interest rates rising above 5%

Meanwhile, S&P 500 earnings could fall 11.3% to $195 per share this year from last year’s $220, according to Shalett’s note, citing estimates from Morgan Stanley’s chief U.S. equity strategist Mike Wilson. 

Read: Morgan Stanley’s Mike Wilson warns U.S. stocks could slump another 22% if recession arrives in 2023

“In contrast, consensus estimates suggest investors are expecting $228 per share in 2023—a modest 3.6% increase,” she said. 

“Consider recalibrating profit expectations for mean reversion” and a risk of a slowdown or potential recession, said Shalett. “Rotate portfolios toward fixed income, value-style stocks, global dividend payers, early cyclicals, enterprise technology and emerging market equities.”

Read: Value stocks trounce growth equities in 2022 by historically wide margin

U.S. stocks were mixed Monday afternoon, after all three major benchmarks rallied earlier in the session. The S&P 500

was trading 0.1% higher in late afternoon trading Monday, while the Dow Jones Industrial Average

slipped 0.3% and the Nasdaq Composite advanced 0.9%, according to FactSet data, at last check. 

Stocks had been rallying Monday amid “soft-landing hopes” ahead of this week’s consumer-price index report, said Edward Moya, senior market analyst for the Americas at Oanda, in an emailed note. An inflation reading for December, as measured by the consumer-price index, will be released Thursday.