The sell-off could be headed for another leg down as too bullish analysts are forced to cut numbers
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Why isn’t the earnings estimate dropping? Mohamed el-Erian observed last week that market was in a new phase. Initially, this was an interest rate panic sell-off and was driven by tightening of financial conditions. He said that today, the market has many elements which could also be a growth fear. He’s probably right. There is currently a growing scare that has reverberated into worries about earnings. This is a change from what we’ve seen so far in the year. Investors are reducing the multiple (P/E ratio) which has caused the stock market to fall. Multiple is the price investors will pay to get a future stream of dividends and earnings. According to Refinitiv, the S & P 500 forward (12-month) multiple has declined from about 22 at the start of this year to 16.4 today. This is lower than the average over the past five years (18.6), and also below the average over the last ten years (16.9). El-Erian suggests that earnings growth and earnings concerns could cause another drop, although the analysts seem not to be aware of this. Estimates for the S & P 500 increased last week, according to Refinitiv. 2022 Earnings today: $228.84 5/6 $2527.50 2023 Estimates today: $251.52 6 $250.53 (Source : Refinitiv). While some of this increase is due to higher energy estimates, most of the estimates for consumer staples and technology remain the same as they were a few weeks ago. Consumer discretionary is the only sector seeing estimates drop. Is it possible that analysts are slowing down in cutting estimates and is this a sign of a new leg down? Nick Raich, who covers earnings at Earnings Scout, agreed that most of the upward revisions in the S & P as a whole is due to revisions in energy stocks, but says that does not explain away analysts in other sectors are not lowering their numbers. I was told by him that the analysts of other sectors are crazy. They should have been kitchen-sinking numbers and taking them down. But they aren’t doing that.” Why is that? Raich said, “Because they’re acting as deer caught in headlights because companies don’t yet know how inflation will affect their earnings for next year.” The analysts don’t do much unless they have more clear guidance. However, there isn’t a shortage of analysts. Although the number of sell-side analysts has declined over the past two decades, there is still a large pool of them and they make a lot of estimates. On average, there are about 20 earnings estimates provided for the 500 stocks in the S & P 500, which means roughly 10,000 earnings estimates are made each quarter. Refinitiv estimates that there are only about 1,700 analysts covering multiple stocks. This would mean an average analyst would cover about six companies. If Wall Street is right, analysts like El-Erian will get busier. If analysts don’t report, then companies that are reporting data may have to beat them by a greater margin in order for their stock to rise. This is because the market believes many of these estimates will fall. With the S & P 500 on the verge of bear market territory, what should long-term investors be doing? We will have Gerard O’Reilly as our guest on Monday’s ETF Edge. He is the co-CEO at Dimensional. Dimensional currently manages assets worth $659 billion. Although they don’t pick stocks, Dimensional seeks to outperform it by continuously seeking sources of higher expected returns that they have discovered through years of research. The perils and risks of market timing will be discussed, as well understanding your risk profile and the ways they generate alpha for clients. Dave Nadig (financial futurist, VettaFi’s), the company that was formerly called ETF Trends, will also be joining us.
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