It is good to know that consumers will continue to demand strong goods and services into 2022.  Although there has been a slight dip in spending recently and issues with supply chains will still be discussed by corporate commentators, it is likely that omicron will slow down but not stop the recovery.  Uncertain is whether consumers will withdraw from stimulus in the second half.

It is the most important component of company profitability. This measures how much profit an organization is able retain after expenses are paid.  S&P 500 operating margins have remained close to a record 13% through most of 2021 because corporations, while faced with higher costs, were able to raise prices.

Even if commodities costs fall, it is possible that corporations will not be as successful at maintaining their margins in 2022.

“We see corporate profits at risk amid rising wage pressures” Savita Subramanian, Bank of America’s Equity & Quant Strategist, said in a recent note to clients.  The labor cost of the average corporate America employee was 40%.  She anticipates wage inflation to keep rising and believes it’s unrealistic to assume that margins will remain as high in 2022. 

It all comes down to whether companies can continue to raise prices, which is problematic after a year of big price hikes:  “If wages are sticky, pricing and demand will determine the have vs. have-nots,” she wrote.

Nick Raich of the Earnings Tracker, which tracks corporate profits, said to me, “The Fed raises interest rates in an atmosphere where earnings growth slows.” 

Although gradual Fed rate increases in strong economies may seem like a good idea, it can be problematic if the Fed raises rates abruptly in the second quarter. This is especially true if the economy slows down. 

A declining economy means that the Fed raises rates is a serious problem.

Raich stated to me that he was concerned about Q2 and 3 estimates. They don’t include rate increases. 

Why would they?  Why not?

The stock market is aware of this problem.

Other than macro problems, several early indicators indicate that 2022 could be more difficult than 2021.

One excellent sign of future stock prices:  analysts that are raising estimates.

Stocks move not only based on future earnings expectations, but also on changes in trends. Raich explained to me that it is the changes in expectations that are most important.  “It is what the expectations will be six- to 18 months from now.”

Most of the 2021 earnings estimates rose through the year. This was a major tailwind for stocks.

This isn’t what’s happening right now.  The fourth quarter estimate, by example, was flat, at around 22%, over the course of several months. 

Raich stated in an earlier note to clients that “EPS estimates should rise at increasing rates for stock prices to be justifiable” this week.  

This is no longer happening.”

 A second red flag:  early reporters are not beating estimates the way they used to.

 2021 was a strange year for earnings.  Inevitably, analysts underestimated the strength and potential impact of the economic recovery.  Analysts often underestimated the strength of economic recovery. Earnings were therefore 20% higher than they expected.

 They may not continue into 2022.

 To date, 20 companies have reported earnings.  These companies have reported earnings for quarters ending in November.

 Those 20 are beating earnings by an average of 13%.  These 20 had beat earnings by 20% during previous quarters.

 The final factor argue for a moderation is simply gravity:  After several whacky years, earnings will likely experience mean reversion, the tendency to revert to long-term averages.

 Average earnings growth in the S&P 500 is typically in the mid- to high- single digits.

 Not surprisingly, that is exactly what 2022 is shaping up to look like:

 S&P 500:  2022 earnings estimates

• Q1:   up 7.6%
• Q2:   up 5.2%
• Q3:    up 7.4%
• Q4:    up 14.3%

Source:  Refinitiv

The 2021 quarter-end numbers will be higher than anticipated, so the 14.3% estimate increase in 2022’s Q4 results is likely to drop.

The bottom line:  Overall earnings for 2022 are likely to be in the mid- to high single-digit numbers, about in line with historic averages.

 “You had big earnings growth in 2021, so now we are going back to normal.  This is 49% growth [for 2021]That isn’t normal.