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As we approach the middle of the year increasing attention is given to the EPS outlook beyond year end 2023
When we gauge the US corporate EPS pulse there are signs of improvement but also caveats around the quality of the recovery.
Exhibit 1 shows the latest consensus 2023 and 2024 EPS growth rate projections across the regions. It also shows where these projections stood at the start of the year (dots). The US 2023 EPS growth forecasts have deteriorated and now stand at3.4%.
Is this the nadir? On a positive tack however, the 2024 EPS growth forecasts have improved and now stand at 13.4%.
We also show in Exhibit 3 following the latest Q1 EPS releases the 2023 and 2024 EPS estimate shave seen their first uptick in over a year.
Exhibit 1: The status of consensus regional EPS growth forecasts
Source: Wilshire and FactSet. Data as of May 17, 2023.
Exhibit 2 shows the 2023 and 2024 consensus top 10 US sector EPS growth rate projections. It also shows the sector weighted contributions that determine the aggregate level. Looking at the 2024 total market EPS growth rate projection of 13.4% ,3.4% of that growth (c.25%) is accounted for by contribution from the technology sector. However, as this is a similar sized contribution to that of 2023 the technology sector is not the main driver behind the 2024 improvement.
We highlight the financials, consumer durables, electronic technology, energy, and health technology sectors as the primary contributors to the improved outlook.
Exhibit 2: US top 10 sector 2023 & 2024 EPS growth rates and contributions.
Source: Wilshire and FactSet. Data as of May 17, 2023.
The EPS growth rate compares the EPS from one period against another. This is why when gauging the quality of the growth rate projections it is important to analyze the profile of the underlying EPS forecasts. Exhibit 3 shows the estimate trails for aggregate US consensus forecasts for 2023 and 2024.It shows that both series or estimates have declined from the start of the year ( 2023 by-6.5% and 2024 by -3.1%). This implies the improvement in the 2024 growth forecast (the gap between the two lines) has not been high quality as it is a function of the denominator series deteriorating at a faster rate.
Exhibit 3: The US 2023 and 2024 EPS estimate trails
Source: Wilshire and FactSet. Data as of May 17, 2023.
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An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) ...
An important second order effect resulting from the collapse of Silicon Valley Bank (SVB) together with fears of further bank contagion is the degree to which these concerns impact broader economic confidence. There is some concern that recent high frequency economic data releases are pointing to a rapid loss of momentum. The debate about the risk of a recession is once again on the agenda.
The beginning of 2023 saw a strong recovery in US labour market and other key economic lead indicators. This created some anxiety in the Fed that this recovery was too rapid, and this saw a tightening of their reaction function. However, since the SVB collapse economic data has subsequently weakened at a rapid rate resulting in a significant lowering in year end rate forecasts.
Chart 1: After a strong start to 2023 US data has started to rapidly deteriorate.
Chart 2 shows the status of bank lending standard surveys for both large and small firms. Lending standards have spiked and are at levels that have only been exceeded three times this century. Given that US non-financial corporates have accumulated corporate debt at a 7.7% CAGR since 2011 taking the total from c. $6tn to $13tna tightening in lending standards marks an important inflection point in this trend. Weaning corporates off debt accumulation and financial engineering would constitute a major paradigm shift.
Chart 2: Bank lending standards have soared – a paradigm shift?
Despite lending standards tightening and real M2 money supply remaining deeply negative our US composite Financial Conditions Indicator has continued to move from restrictive to neutral. This has been driven partly by declines in both bond yields and real yields. In addition, the dramatic decline in US interest rate expectations has seen US interest rate differentials (versus other G7 economies) narrow. This has contributed to the decline in the dollar as can be seen in Chart 3.
Chart 3: Narrowing US interest rate differentials have contributed to the decline in the dollar
Source: Wilshire, Refinitiv, Factset and Federal Reserve. Data as of April 13, 2023
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Share buybacks in the US have been a key feature of market dynamics during the post-GFC period...
The environment of financial repression provided companies with the perfect tailwind to pursue buybacks that boost both EPS and shareholder returns. However, it appears that this secular driver has peaked and is losing momentum.
Chart 1: US (ex financials) quarterly and rolling 4Q buybacks (USD, Bn)
US buybacks (ex Financials) peaked at trailing 4-quarter rate of $1tn in Q3 last year and have eased back since. The opportunity to repurchase shares on a large scale has been rational behaviour for companies in the post-GFC landscape of extremely cheap money and rising free cashflow. However, with interest rates rising and profits declining, there will now surely be big question marks over companies' willingness to sustain buybacks at these levels.
Chart 2: US technology companies have been the dominant force behind US buybacks
Chart 2 shows the US sector buybacks as a percentage of total (ex financials) buybacks, demonstrating the dominance of the technology sector. Over the past decade technology has seen its share of buybacks rise from 20% to a peak of over 50% in mid-2021. The share of the next four biggest sectors has largely remained flat and range bound. With technology buybacks now in decline, there will be big question marks over which sectors, if any, will pick up the baton.
Chart 3: Comparing the US dividend yield with the buyback-adjusted yield
Chart 3 shows the impact on the effective yield returned to shareholders when buybacks are included. The buyback-adjusted yield rises to 4.3% (versus a 1.6% dividend yield). Compression in the adjusted yield will impact long term return projections.
Source: Wilshire and FactSet. Data as of March 13, 2023
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The collapse of Silicon Valley Bank (SVB) and fears of contagion have hit global bank stocks, rippling through to wider risk off market sentiment
The collapse of Silicon Valley Bank (SVB) and fears of contagion have hit global bank stocks, rippling through to wider risk off market sentiment. Recent events could well be the first of many unintended consequences of a rapid shift from ultra-accommodative to restrictive financial conditions.
Chart 1: Asset class returns since 7th March (SVB news)
Declines in global bank stocks and contagion concerns have rattled equity markets and economically sensitive assets such as oil since the news on SVB broke. This has also led to a flight to perceived safe-haven assets such as gold.
Chart 2: Regional bank sector returns since the SVB news
The collapse of SVB was initially seen as isolated to the US with the US banking sector experiencing the worst of the sell-off in the few days that followed the SVB news. Contagion fears soon led to a sell-off in banks globally, with particular concern over the value of bond portfolios held by many institutions. In recent days the focus has shifted on to European banks, with the spotlight on Credit Suisse which saw its shares plunge by a quarter on the 15th March. As Chart 2 shows Asian banks, which are seen as relatively well capitalised have held up well and only seen modest declines.
Chart 3: Contagion fears in the banking system have led to a dramatic decline in US year end 2023 rate expectations
The upshot of recent events has been the significant decline in US interest rate expectations. Markets had been ramping up rate expectations on the back of a sequence of strong economic data, pricing in a 50bps hike from the Fed at its March meeting. As the chart 3 shows, following recent events in the banking sector markets now expected the Fed to halt its tightening cycle, and are now in fact forecasting around 75bps of rate cuts by the end of the year to 3.9%.
Ultimately, the sharp fall in rate expectations could be an overreaction if the contagion proves to be limited. However recent events have created yet another conundrum for the Fed. SVB could be the first of many casualties to emerge as restrictive financial conditions start to take their toll.
Source: Wilshire, Refinitiv and Federal Reserve. Data as of March 15, 2023
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The improvement in risk appetite in recent months has been underpinned by a 'Goldilocks' scenario of easing financial conditions
The improvement in risk appetite in recent months has been underpinned by a 'Goldilocks' scenario of easing financial conditions, the prospect of a soft landing for the US economy and the expectation that US interest rates are close to peak levels. However, this may have all come too soon.
Chart 1: Have we now have hit a nadir in economic data?
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
The last few weeks have witnessed a succession of strong data releases. As Chart 1 shows this includes a sizeable rebound in the US ISM services index and the well-above expectation January non-farm payroll figures. The latter further confirming the resilience of the US labour market. Chinese PMIs have also inflected higher following the reopening of the economy post-Covid. Further signs of improving activity in the world's second largest economy will likely prove a boost to growth globally.
Chart 2: We have seen a sharp rise in US market interest rate expectations in recent weeks
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Chart 2 shows the latest US market interest rate curve out to the end of 2023 versus the curve at the end of January, before the release of the stellar non-farm payroll figures. The red line shows the Fed's current interest rate projections. As we can see, the recent sequence strong set of data has fed through to a marked rise in US market interest rate expectations. Markets now see rates peaking later at 5.25% in September (up from 4.9%) and the degree to which rates are expected to fall back has also eased significantly. Are markets now beginning to agree with the Fed's view that rates may have to stay higher for longer?
Chart 3: Total return decomposition shows PE re-rating as the key driver of returns-both on the way up and on the way down
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Chart 3 shows the total return decomposition for the US, UK and Europe ex UK, breaking the returns down by dividend and shifts in EPS and PE. We can see that last year's declines to the lows in October were driven by the PE de-rating, with EPS actually rising in the US and UK. Contrast this with the returns from the October lows to date and we can see a reversal of the 2022 profile, with a PE re-rating the main driver, while EPS in all three regions have declined.
Chart 4: US 2023 and 2024 EPS estimates have seen further downgrades since the market low in October
Source: Wilshire, Refinitiv and Factset. Data as of February 8th, 2023
Drilling further into the status of US EPS, a constant theme throughout the Goldilocks rally has been further downgrades to US EPS estimates. Chart 4 shows the progression of 2023 and 2024 EPS estimates since the start of last year. As the chart highlights, the market rally from the low in October has coincided with further downward revisions to analyst's EPS estimates, more pronounced in the 2023 numbers which have declined -7.5%. This has further magnified the (low quality) US 12-month forward PE re-rating we've seen since October we highlighted in Chart 3.
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Markets are convinced that inflation has already peaked and that interest rates should follow suit by Q2 this year.
The Fed remains more skeptical and awaits evidence of services inflation turning a corner.
Chart 1 shows the returns accrued by the FT Wilshire 5000, US bonds and the US dollar from the low point reached on October 14th last year and performance YTD for 2023. While both equities and bonds have rallied strongly the dollar has fallen sharply. The common denominator between these divergent moves is growing conviction that US inflation has already peaked and that US interest rates will follow suit.
Chart 1: Move in US assets since October 14th low and YTD
Source: Wilshire, Refinitiv, FactSet. Data as of January 17, 2023
Chart 2 plots the key US inflation indicators and shows a profile of inflation peaking (and subsequently declining) over the last six months. In fact the Fed's key indicator the Core PCE deflator peaked in February 2022. It also appears that the Fed ramped up its hawkishness as evidence of the peak started to appear.
Chart 2: Key US inflation gauges appear to have peaked several months ago
Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023
Chart 3 shows that the key driver behind the peak in inflation has been the rapidity of the decline in both goods inflation and input prices as measured by the PPI indicator. Services inflation has yet to peak, and the Fed will probably need to see this confirmed in subsequent data to change tack on interest rates.
Chart 3: Declining goods inflation but services inflation (the Fed's focus) remains elevated.
Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023
Chart 4 plots both the markets interest rate and Federal reserve dot plot curve forecasts. The market expects rates to peak close to 5% in Q2 but then to 'fade' lower into the second half of the year as growth headwinds and disinflationary pressures push rates lower. However, Fed forecasts paint a picture of continued increases throughout the course of the year reaching peak rate by the end of the year (higher for longer).
Chart 4: Mind the gap between the market and Fed interest rate forecasts
Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023
While the Fed is still waiting for more evidence of inflation peaking it has been concerned that the deliver of restrictive financial conditions runs the risk of slowing the economy too aggressively and has subsequently started to rein in (taper) the scale of interest rate increases it is delivering at the FOMC meetings (see Chart 5). Tapering has been a contributory factor behind the weakening of the dollar.
Chart 5: The Fed is tapering the magnitude of rate hikes - impacting the dollar
Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023
Read more in our latest Market Driver Insights report.
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The likelihood of the delivery of sustained disinflation in 2023
Despite persistent fears that financial conditions are sufficiently restrictive to cause a slowdown next year, the positive market reaction to the weaker than expected October CPI data seemed to indicate a transition to a new phase of inflation dynamic analysis - the likelihood of the delivery of sustained disinflation in 2023.
Bad economic news feeds this narrative and therefore could now be seen as good news.
Chart 1: On the cusp of phase 3 of inflation analysis
Source: Wilshire, Refinitiv. Data as of November 15, 2022
Intensified focus on the Fed’s disinflation forecast for 2023
Chart 1 plots the progression of the Fed’s core PCE inflation indicator. The twelve month period between February 2021 and February 2022 saw the inflation rate almost triple, generating the hawkish tilt by the Fed. Since then, the inflation rate has plateaued (albeit at an elevated level).
The focus now turns to the plausibility of inflation moving sequentially lower next year as predicted by the Fed. Their current forecast of year-end 2023 inflation reaching 3.1% requires a monthly run rate of 0.3%. A run rate of 0.2% a month would deliver a 2.4%-year end inflation level.
Forward looking indicators such as the ISM prices paid index point to continued downward pressure on headline inflation in the coming months.
Chart2: The ISM manufacturing prices paid index points to lower US CPI
Source: Wilshire, Refinitiv. Data as of November 15, 2022
Perception that inflation could be peaking and then encountering disinflationary headwinds (after the October CPI report) produced a downward shift in the US interest rate curve as can be seen in Chart 3.
Any further signs of weakness in final demand (bad news) could now be the catalyst for continued downward shifts in the interest rate curve (good news).
Chart 3: US market rate expectations fell after the lower-than-expected US CPI numbers
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The second half of 2023 has seen the 2023 EPS growth rate forecast start to decline
As can be seen in Chart 1, the second half of 2023 has seen the 2023 EPS growth rate forecast start to decline. This has clearly been connected to the rapidity of the commensurate decline in forward looking GDP growth forecasts.
Chart 1: 2023 EPS growth forecasts have followed GDP forecasts lower
Source: Wilshire and FactSet. Data as of November 15, 2022
Chart 2 shows the sector weighted contribution to the aggregate 2023 market EPS growth rate. In May the forecast was for 12% EPS growth, and this has now declined to 7.9%. The main contributors to this 4.1% decline were the negative contributions from the tech and health sectors.
Chart 2: Comparing the US vs World ex US PE ratio moves over the last 20 years
Source: Wilshire and FactSet. Data as of November 15, 2022
Chart 3 shows the progression of quarterly US EPS forecasts out to the end of 2023, with the blue bars showing the Q/Q growth rates and the grey line showing the quarterly forecast EPS (USD). As the chart shows, there is high levels of seasonality forecast over the next 12 months or so.
After flat or negative EPS growth expected for the next three quarters, a lot appears to be hinging on a recovery in EPS in Q3 and Q4 of next year.
Chart 3: A lot is riding on the delivery of a positive EPS inflection in Q3 2023
Source: Wilshire and FactSet. Data as of November 15, 2022
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Scale of the drawdown in global equities in 2022 has produced a significant de-rating with US equites experiencing one of the largest PE contractions
Chart 1 shows the status of regional 12m forward PEs, where these sat at the end of last year and the scale of the de-rating experienced so far in 2022. The UK and US have seen valuations decline by around a third, China and Europe ex UK by a quarter.
Chart 1: The scale of PE de-rating experienced across the regions in 2022
Source: Wilshire and FactSet. Data as of October 16, 2022
Taking a longer-term view of valuations, Chart 2 shows the 12m forward PE for the US and World ex US over the past 20 years. The chart shows the sheer scale of the de-rating over the past 2 years. From its peak in September 2020 the US 12m forward PE has declined 36%, with World ex US also declining by the same quantum from its peak in July 2020. Although valuations are not far from the Covid sell-off lows, they are someway from the lows of the GFC, where the US and World ex US 12m forward Pes fell to 8.7x and 7.1x, respectively
Chart 2: Comparing the US v World ex US PE ratio moves over the last 20 years
Source: Wilshire and FactSet. Data as of October 17, 2022
Chart 3 shows the Fed Model valuation (equity earnings yield minus 10-year government bond yield) since 1992 and looks at the average levels over 3 distinct periods. As we can see, although the current Fed Model valuation is below its post-GFC average, it is above the pre-GFC 2002-2008 average, and well above the negative levels experienced in the 1990s. From a Fed Model valuation standpoint, the rise in bond yields this year has partially offset the impact of the US equity market de-rating.
Chart 3: The US 'fed model' valuation looks stretched versus the last 10-year range but not versus the pre GFC period
Source: Wilshire, Refinitiv and FactSet. Data as of October 17, 2022
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