(Bloomberg Opinion) — Wall Street’s stock market soothsayers weren’t entirely wrong about 2022. In fact, S&P 500 Index earnings are on pace to match the consensus forecasts that analysts submitted about a year ago. Stock prices, however, are another story.
How could analysts and strategists have been so seemingly right about the fundamentals and so off the mark about the investment implications? A look at the year that was offers a few clues. One takeaway is that, while it’s still important to keep an eye on the sell-side research and take cues from the direction of revisions, 12-month outlooks shouldn’t be taken too literally.
The sell side is poised to notch one of its best years for earnings-per-share projections in recent history. At the start of the year, analysts were expecting about $221 a share in S&P 500 adjusted earnings in 2022, based on bottom-up analysis. Unless companies deliver shockingly bad (or good) fourth-quarter results, companies will probably end the year within 1% to 2% of that, for what may be the most accurate consensus forecast since 2014.
Of course, the consensus may end up being right for the wrong reasons. Consider:
- Consumer discretionary earnings are likely to round out the year at about 23% below the levels forecast in December 2021.
- Communication services earnings will probably come in about 16% below.
- But they’re both offset by energy EPS, which could exceed December 2021 expectations by more than 100%.
A year ago, few analysts understood the blow that consumer discretionary companies would take, particularly those that sell durable goods. During the early days of the pandemic, Americans overbought on appliances, furniture and electronics, and the trend reverted drastically in 2022. That meant downward revisions for companies such as Best Buy Co. Inc. and Whirlpool Corp.
But consumer spending didn’t disappear entirely; the money just went elsewhere. People went out more, so the makeup business flourished. They also spent more for increasingly expensive food and fuel, so Exxon Mobil Corp. had an epic year and supermarkets chugged along. As a result, EPS growth overall remained relatively hardy.
Unfortunately, equity markets are more than just a bet on earnings, and strategists got the other parts woefully wrong this year. In December of last year, the average estimate was for the index to end 2022 at around 4,950, and at 3,821.62 as of Tuesday’s close, it’s 23% below that level.
In effect, strategists got the multiple — the “price” in the price-earnings ratio — wrong, and a lot of that came down to what transpired in monetary policy. In late 2021, few investors suspected that inflation would be as widespread and persistent as it was, much less that the Federal Reserve would respond by pushing the federal funds target rate to a range of 4.25% to 4.5%, the highest since 2007.
That has swept through the stock market and is probably the biggest reason earnings multiples have compressed from nearly 23 times in December 2021 to about 17.5 times now. Higher risk-free rates mean that bonds, on a relative basis, do a better job of competing for investors’ attention. Higher benchmark borrowing costs also make it more expensive for companies to finance themselves.
What isn’t reflected in those valuations is much of an additional equity risk premium. If the US looks as if it will slip into a recession, history shows that investors will demand steeper discounts to compensate for holding risky securities through such a storm, and valuations could conceivably compress further even if bond yields decline.
The question, of course, is what this means for 2023. The average projection among 22 strategists in Bloomberg’s latest survey is for the S&P 500 to close out next year at around 4,078, 6% above current levels. That’s far from the doomsday scenario that some bears have in mind. It’s not great, either.
But how much weight does that outlook deserve? Only seven times in 23 years of data has the actual index value at the end of December landed within 5% of the consensus projection at the start of the year. Nine other times, Wall Street aimed much too high, and in seven other years the projections were far too low. What’s more, the guesses tend to be particularly bad in times of economic upheaval, with the biggest whiffs coming in 2001, 2002, 2008 and now 2022.
Frankly, that’s understandable. As in meteorology, projections rendered so far in advance are bound to seem ridiculous with the benefit of hindsight, and they’re intended to be revised as you get closer to the moment in question. Nevertheless, it’s helpful to have a number in mind as we look ahead to an uncertain year, just as it’s reassuring to plot the path of a hurricane that’s likely to shift course as it draws closer to land. Even if the forecast looks relatively sanguine, you still have to consider a range of outcomes and prepare for the worst.
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To contact the author of this story:
Jonathan Levin at [email protected]