The stock market is facing a potential decline as Wall Street's predictions for corporate earnings start to falter. Analysts, once optimistic about profits, are now experiencing a shift in sentiment. Let's examine the data to understand the recent level of optimism.

Optimistic Outlook for 2023 Earnings

According to FactSet, aggregate 2023 earnings per share forecasts for companies in the S&P 500 have witnessed a modest 1.4% increase over the past six months. Sales estimates, on the other hand, have risen slightly below 1%. Additionally, estimates for profit margins show a marginal improvement, as the pressure stemming from higher staff compensation eases.

Upward Revisions in EPS Forecasts

RBC's analysis reveals that approximately 58% of revisions to forecasts for 2023 and 2024 EPS for S&P 500 companies have been upward. This figure marks a significant rise from less than 40% earlier this year.

Historically, during periods immediately following a recession and the onset of a new economic expansion (e.g., 2003, 2019, and 2021), this percentage has reached peaks of about 80%. However, when the economy has experienced several years of growth and concerns about a potential slowdown arise, the figure tends not to surpass 60% or 70%. In fact, it often dips below the current level, suggesting that a greater proportion of forecast revisions may involve downward adjustments.

As the stock market awaits further developments, investors must navigate this evolving landscape with caution. Monitoring corporate earnings forecasts and market sentiment will be crucial to making informed investment decisions.

Earnings Estimates Show Signs of Peaking

Early indications suggest that earnings estimates have reached their peak. Although EPS forecasts have increased in the past six months, recent weeks have shown a decline. According to DataTrek Research, estimates for aggregate third-quarter EPS for S&P 500 companies dropped approximately 0.4% to $57.85 last week.

DataTrek's founder, Nicholas Colas, expects further cuts in the coming week as analysts finalize their Q3 estimates. A weakening economy due to higher interest rates might exacerbate this downward trend. While the Federal Reserve is nearing the end of its interest-rate hikes, it will maintain elevated rates for some time. Higher rates typically impact the economy and company sales with a delay, indicating further damage is likely.

The stock market's current valuation is already significant, emphasizing the importance of these factors. The S&P 500 is trading at around 18 times the EPS predicted for its component companies over the next twelve months, compared to just over 16 times at the beginning of the year.

Despite rising bond yields, which diminish the value of future profits and should dampen investors' willingness to pay for earnings, the stock market remains optimistic about earnings growth.

Considering the potential for analysts to reduce EPS estimates, stocks could experience significant downside. Exercise caution when navigating this market.

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