US earnings forecasts creep down as costs creep up

Tuesday’s batch of economic data from the US may ease fears of a recession, as job vacancies rose, consumer confidence rebounded and house prices stayed firm, all eyes will now switch to Thursday’s manufacturing data.

The Institute for Supply Management’s purchasing managers’ index (PMI) for manufacturing is on a long losing streak that goes back to March 2021 and behind the headlines the order number is looking weak, too. Another softer set of readings will only serve to highlight the US Federal Reserve’s dilemma, as it looks to fight inflation on one hand without crashing the world’s largest economy on the other.

The last PMI reading for US manufacturing was 52.8, just above the 50 mark, so it was still indicative of growth – any drop below 50 is seen as heralding a slowdown in activity or even a recession. The good news, at least, is that economists expect the reading for August to come in at 52.1.

But the details behind the headline reading may be worthy of further study. The order intake sub-index has come in below 50 for two consecutive months and a further weak month or two for new business levels would surely start to take its toll on the headline indicator.

Source: Institute for Supply Management, Refinitiv data

Both the headline and the new orders readings from the ISM survey had begun to weaken markedly in 2019 and at the time fears of a US recession had started to build. But then came covid-19, lockdowns and a massive amount of fiscal and monetary stimulus from the Fed and the US Government. Both jolted the US economy even if the backdrop was hardly promising.

But a fresh slowdown makes sense in this context, especially as the Government is no longer handing out stimulus cheques (although the student loan forgiveness programme can be seen as a step in that direction), and the US Federal Reserve is both raising interest rates and withdrawing Quantitative Easing.

A downturn now could just be seen as the logical extension of a trend that began in 2019 after a decade-long upturn that had begun to look a bit long in the tooth and witness some appalling capital allocation decisions, as stock markets ran riot and a fresh mania for loss-making, blue-sky companies developed.

US corporate profits growth had slowed almost to a standstill in 2019 and profit margins dipped. Again both trends that were consistent with the thesis of at least a slowdown, even if they were not conclusive when it came to forewarning of a recession.

Research from S&P Global is hinting at fresh decline in US corporate profit margins as input costs rise and growth slows.

Source: S&P Global Research

Analysts have started to trim their earnings estimates for corporate America, too. As of March, analysts had pencilled in earnings per share (EPS) of $226 for 2023 and $247 for 2023 for the S&P 500 overall. They have now cut those numbers to $211 and $241 respectively.

That figure of $211 for 2022 means this year is now expected to see virtually no growth at all and it will be interesting to see how close the S&P 500 index gets to generating 14% growth in EPS in 2023.

Source: S&P Global Research

If it does, the S&P 500 trades on 16.5 times forward earnings, a multiple that does not look excessively expensive or unduly cheap relative to the index’s recent history. A resolution to the energy crisis could mean that earnings surprise in the upside and US stocks look cheap. Equally, a prolonged period of oil and gas price pain to match that of, say, the 1970s, would bode less well and perhaps leave both earnings estimates and the S&P 500 index exposed on the downside.

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