Need to Know: The market is too optimistic about corporate earnings for 2023. Here’s why.

However, anyone hoping for earnings growth even managing to be flat for 2023 “is very naïve”, according to Peter Ganry, head of equity strategy at Saxo Bank.

Ganry notes that the 12-month forward earnings per share estimate on the S&P 500 is currently at $235.34 which is 7% above the expected full-year 2022 EPS of $219.38. That’s too high, he reckons.

“There is nothing unusual in this divergence conflicting with reality as sell-side analysts have a natural long bias…and are slow to react and incorporate new information. The fact that the 12-month forward EPS estimate on S&P 500 is only 4% from its recent peak despite the ongoing margin compression says it all.”

And indeed it is over-optimism on corporate margins that may trip up investors. It’s important. As the chart below shows looking over a short time period such as one year, the changes in earnings are strongly associated with changes in the operating margin.

“If you take EPS of $220 next year and divide with the expected revenue per share of around $1,800 which fits pretty well with a 1-year lag in US nominal GDP growth, then you get a net profit margin of 12.2% which exactly where the 12-month trailing net profit margin stood at in September,” Ganry says.

That implies that S&P 500 companies can maintain their net profit margin next year. That’s “a completely detached assumption” for several reasons.

First, companies have been constantly talking about margin pressures in their Q3 earnings reports, particularly regarding wage pressures and also commodities and energy costs. Indeed, the growth of wages – typically the biggest cost for many companies – in the U.S. and Europe is running at its fastest pace in many decades.

“High wage growth is difficult to offset in an inflationary environment when recent price hikes by companies have now reached a point where they are destructive for volume growth (Home Depot being a recent example of this),” Ganry notes.

Next: “The operating and net profit margin are both coming off historically high levels and margins are a mean reverting process, so this alone indicates that margins will trend down from current levels,”

 Ganry adds: “The fact that the Q3 net profit margin in S&P 500 is 11.9% (below the 12-month trailing figure) and trending lower suggests that margins are coming down faster than expected”.

Another downside risk to earnings per share in 2023 is that revenue growth could be lower than current estimates as nominal GDP growth is coming down to 6.7% annualised in Q3, down from the average 12.2% annualised in 2021.

Finally, the move higher in interest rates as the Fed continues to fight inflation will force up corporate financing costs. “Not by much because only 20% of the outstanding debt is getting refinanced over the next 12 months, but it will still subtract from operating income before we reach EPS impacting the net profit margin.”

“If we are right about our operating margin call for 2023 then the impact on S&P 500 will vary depending on the equity risk premium (P/E ratio), revenue growth and the actual net profit margin,” says Ganry. The S&P 500 is sensitive to these variables.

Markets

Markets are going into the holiday break on a subdued note. S&P 500 futures
ES00,
+0.16%
are slightly, with benchmark 10-year Treasury yields
TMUBMUSD10Y,
3.769%
barely changed at 3.754%. Oil
CL.1,
-2.35%
is again under pressure , however, as worries about soft China demand as Beijing implements more COVID-19 lockdowns.

For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.

The buzz

Credit Suisse stock
CSGN,
-3.81%
slumped 5% to hover near record lows after the embattled Swiss bank delivered the latest in a long line of miserable trading updates.

Shares in Apple
AAPL,
+1.47%
are a fraction softer in premarket trading as news emerges that workers at China’s biggest iPhone factory were beaten and detained.

A surprise quarterly loss revealed after the closing bell on Wednesday, has hit Nordstrom shares
JWN,
+6.49%,
down nearly 10%.

With markets shut on Thursday for Thanksgiving and everyone apparently going shopping on Friday, it seems all the week’s economic data has been crammed into Wednesday. So, taking a deep breath…here goes….

At 8:30 a.m. Eastern we have the weekly initial jobless claims alongside October durable goods orders. At 9:45 a.m. come the November S&P flash U.S. manufacturing PMI and services PMI. Then at 10 a.m. the October new home sales report is delivered at the same time as the November University of Michigan consumer sentiment index and 5-year inflation expectations. Finally, at 2 p.m. the minutes of the Federal Reserve’s recent rate-setting meeting will be published.

Ronaldo’s out and now the Glazers may be departing Manchester United too. The U.S owners of the English Premier League football giants, who also own the Tampa Bay Buccaneers, say they are exploring options which may include a sale of the club. United’s shares
MANU,
+14.66%
jumped 15% late on Tuesday and are adding another 11% in Wednesday’s premarket action.

Best of the web

How retailers are reshaping the advertising industry.

Investor home purchases fall 30% amid rising interest rates.

Five things not to buy on Black Friday.

The chart

Consider this from Bespoke Investment if you come back from Thanksgiving and fancy a spot of trading into the New Year.

“The S&P 500 has risen from the close on the Wednesday before Thanksgiving through the end of the year roughly three-quarters of the time with an average gain of 1.93%. When momentum has been dragging the index lower year to date, though, rest-of-year performance has been less positive. Again looking at years in which the index has fallen at least 10% headed into Thanksgiving week as is the case this year, positive returns through the end of the year have been less common only happening half the time with an average decline of 0.1%,” says Bespoke.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

Ticker

Security name

TSLA,
+1.22%

Tesla

GME,
+4.53%

GameStop

AMC,
+0.69%

AMC Entertainment

NIO,
-0.10%

NIO

AAPL,
+1.47%

Bed Bath & Beyond

AMZN,
+0.80%

Amazon.com

COSM,
+86.93%

Cosmos Holdings

MULN,
-11.50%

Mullen Automotive

APE,
-0.79%

AMC Entertainment preferred

TSM,
+3.27%

Taiwan Semiconductor

Random reads

T. Rex auction cancelled – is it actually a 20th Century Boy?

Smelly cat caught in a bag.

A LOT of extra incentive to win the World Cup.

Need to Know starts early and is updated until the opening bell, but sign up here to get it delivered once to your email box. The emailed version will be sent out at about 7:30 a.m. Eastern.

Listen to the Best New Ideas in Money podcast with MarketWatch reporter Charles Passy and economist Stephanie Kelton