Two the Point — Earnings in the Driver’s Seat

This was a busy week of earnings, with closely watched stocks such as Microsoft releasing results. As companies continue to report, two key components of our 2023 outlook are becoming clearer. 

First, as we expected, earnings forecasts for this year are falling.  A persistent reduction in these expectations will be a headwind for significant and sustained stock market gains in 2023.  Second, the market’s focus is at a key transition point – shifting away from fears of inflation and higher interest rates to fears about an earnings/economic recession.

Microsoft traded lower after its earnings release, largely due to guidance for 2023 – a 7-8% sequential decline in the March quarter Azure (cloud) growth, which would be the most since the pandemic.  It’s not just Microsoft, earnings growth expectations for the fourth quarter of 2022 were -1.6% as of January 1, 2023.  Now those expectations are for -3.5% growth.  Looking toward the full year 2023, growth expectations are also falling.  Consensus estimates are calling for 3.5% earnings growth, versus expectations for well over 5% just a month ago.  If we are correct, and economic growth is flat to down this year, current expectations are still too high, in our view.

As the chart below demonstrates, there is a wide dispersion among 2023 analyst earnings expectations – a sign of uncertainty.  Earnings estimates tend to be most inaccurate when economic growth is slowing…as it is today.  Thus far, the market advance in 2023 has been driven by valuation multiple expansions as earnings expectations fall.  We do not believe this is something investors should count on to sustain a move back to old highs.

Source: Piper Sandler Macro