SUMMARY: We are wrapping up our Fed/EPS outlook survey today. You can take it HERE and results will be out this afternoon.
Fed officials have signaled a general level of comfort with the easing of financial conditions, and inflation appears to be slowing. All else equal, on a soft-landing path, inflation moves lower while PMI readings stabilize. That is good for Early Cyclicals and factors like Earnings Turbulence, EPS Momentum, and Price Failure that are negatively correlated with inflation readings and positively correlated with PMIs. That stance has generally worked, but internals have become more complicated.
Over the past few months, market internals have become less binary and risk-on/off rotations more nuanced. Increased return dispersion within sectors, industry groups, and factors should be expected given the high odds that we are back to a normal macro backdrop (more on how we define that HERE). It is important to keep micro forces specific to today’s backdrop in mind. The S&P has been flat over the past week, while higher debt risk names are up 80bps, IWM is up 1%, Destocking Reversal names are up 2.4%. Themes tied into broad macro trends remain our focus.
Pretty Good Fundamental Outlook for 2024: S&P sales are expected to rise 4.5% next year, which is a pretty low bar in a backdrop of +6% nominal GDP growth. If consensus margins and sales are correct, EPS would be +11% in 2024. As long as the Normal macro backdrop holds, the skew on revenue and EPS growth estimates is likely higher not lower.
Earnings sentiment coming out of 3Q reporting season deteriorated. The most mentioned topic was macro headwinds/tailwinds, and both were mildly negative. That is an important point. The largest concerns about earnings were not around company data. Management was concerned about macro forces that might negatively impact performance. Sentiment toward margins INCREASED in 3Q, consistent with the 60bps increase in margins q/q.
We get it. Slowing growth and higher yields are a headwind for profit levels in 2024. But as go through in the report, even with flat margins and modest single digit revenue growth, S&P EPS would be up ~$10 (+4%) in 2024.
Full report below…
MARKET VIEWS: Market internals have become less binary over the past few months. Risk-on/off rotations have been more nuanced. Our high Debt Risk basket (MS22DEBT Index on bbg) lagged on Tuesday (-55bps relative) but rallied yesterday (+73bps relative). In general, companies with poorer credit ratings led internals during the early phases of the rally. More recently, returns to credit ratings have been more mixed. In general, Early Cyclicals with lower credit ratings have outperformed while poor credit Defensives have lagged.
Increased return dispersion within sectors, industry groups, and factors should be expected given the high odds that we are back to a normal macro backdrop. The yield curve is inverted and rates are 525bps higher, but the level and vol of yields, inflation, payrolls, and PMIs are all more consistent with a Normal backdrop than a Transition or Recession backdrop.
If we remain on a soft-landing path, inflation will move lower while PMI readings stabilize. Factors negatively correlated with inflation readings and more positively correlated with PMI changes would benefit, such as Earnings Turbulence, EPS Momentum, and Price Failure. Reheating of inflation would bring higher recession risk and would be a tailwind for Growth, Price Momentum, and Quality names.
Pretty Good Fundamental Outlook for 2024: S&P sales are expected to rise 4.5% next year, which is a pretty low bar in a backdrop of +6% nominal GDP growth. Revenue and EPS expectations imply profitability will expand almost a percentage point next year. If margins were flat y/y in 2024, 4.5% sales growth would still put S&P EPS up about 4% y/y. If consensus margins and sales are correct, EPS would be +11%. As long as the Normal macro backdrop holds, the skew on revenue and EPS growth estimates is likely higher not lower.
There has been a lot of concern about the weakening of earnings sentiment coming out of 3Q reporting. Weaker sentiment is a headwind for revisions and trends to lead actual changes in actual earnings. It is important to keep in mind WHY sentiment deteriorated. The most mentioned topics were macro headwinds/tailwinds, and both were mildly negative (change in level LHS, % of companies making comments RHS). That is an important point. The largest concerns about earnings were not around company data. Management was concerned about macro forces that might negatively impact performance.
There was also an odd divergence between earnings sentiment and view on profitability. Management sentiment toward margins INCREASED in 3Q, continuing the upward trend it has been in for the past year. Margin sentiment gains were broad-based, rising across most sectors and industry groups, even as overall earnings sentiment deteriorated in 3Q. Historically, margin sentiment trends have been a good directional indicator for actual margins.
The improvement in margin sentiment lined up well with the inflection point in actual S&P margins over the past two years. Falling margin sentiment in late-’21 to ’22 predicted the decline in profitability. The improvement in margin sentiment in late-’22 lined up with the rebound in profitability seen over the past three quarters. We get it. Slowing growth and higher yields are a headwind for profit levels in 2024. But as we showed earlier, even flat margins next year would put S&P EPS up ~$10 in 2024.
