‘Forward estimates have been cut much larger than usual,’ says BofA
The S&P 500 risks another leg down after a “complete U-turn” in 2023 earnings-per-share estimates for the U.S. stock-market index, according to a BofA Global Research note.
“Forward estimates have been cut much larger than usual,” BofA equity and quant strategists said in a research note Monday. They said that estimates for earnings per share, or EPS, for the S&P 500 in 2023 are down 3.6% since the start of October to $233 — 2.9 times the typical cut.
While the 2023 EPS consensus remains “well above” BofA’s forecast of $200, estimates are 8% below the June peak of $252, according to the note. Revisions so far this year are “now trending in line with the historical average,” and if the 2.9x pace of cuts continues through year-end, the S&P 500 could see “no EPS growth next year” as 2023 consensus would fall to around $220, the strategists warned.
The above chart shows how 2023 EPS revisions stack up against the historical average, while also considering exclusions of the COVID-19 crisis and 2008 global financial crisis.
“Actual EPS historically came in 4% below where consensus stood in the beginning of the year, which also points to potential for negative growth,” the strategists said.
Meanwhile, estimates for S&P 500 EPS in the fourth quarter are down 4.3% since the beginning of October, or 2.5 times the typical estimate cut “at this point in earnings season,” they wrote.
Analysts at Goldman Sachs Group said in a research note Friday that they lowered their 2023 EPS growth forecast to 0%, from a previously expected increase of 3%, after the S&P 500’s net margins contracted in the third quarter for the first time since the pandemic on a year-over year basis. They wrote that “weak” third-quarter margins presage “a headwind” next year.
Goldman kept its price target for the S&P 500 at year-end at 3,600 and also maintained its 2023 forecast of 4,000.
Equity risk premium
The BofA strategists said in their note Monday that they continue to expect that “rising earnings risk will lead to a higher equity risk premium.”
Their forecast for a 9% earnings drop in 2023 should translate into an increase in the equity risk premium of 100 basis points, according to the note. And that size increase translates into an S&P 500 price of around 3,200 based on today’s rates, they said, pointing to a 1.7% real yield for the 10-year Treasury note.
That valuation for the S&P 500 is below current trading levels, as well as the index’s 2022 closing low of 3,577.03 on Oct. 12, according to Dow Jones Market Data.
The U.S. stock market was trading mostly higher early afternoon Monday, with the S&P 500 SPX, +0.96% rising 0.2%, according to FactSet data, at last check. The Dow Jones Industrial Average DJIA, +1.31%, a blue-chip gauge of stocks, gained 0.7% in early afternoon trade, while the technology-heavy Nasdaq Composite COMP, +0.85% was about flat.
All three major stock benchmarks fell last week amid investor anxiety over aggressive interest rate hikes by the Federal Reserve as it battles high inflation.
The BofA strategists expressed concern over “looming recession risk” and falling corporate sentiment. “Mentions of weak demand have spiked to prior recession levels,” they said in their note Monday.