Monday Nov 20, 2023

Equity Strategy: Earnings outlook - consensus is implying both a margins and topline reacceleration next year

Speaker: Mislav Matejka, CFA, Head of Global Equity Strategy

Earnings growth this year is on track for a largely flattish outcome. For next year, consensus is implying a significant pickup, at 10% EPS growth globally. Both topline and margins are expected to improve vs this year. There are risks to this, in our view, especially given that the corporate earnings are at present above historical trends, and that the starting point of profit margins is elevated. The consensus view goes against the reducing pricing power that corporates are starting to face - as PPIs have entered negative territory, there is downside risk to earnings, not upside. The headwind to margins could come from higher cost of goods sold through lagging wage increases, as well as higher cost of financing, while on the other side sales mix and volumes could deteriorate. Put together, next year corporate EPS growth could end up more flattish, rather than up, and this is without having recession as a base case. At the sector level, into next year we see downside earnings risks to Banks, Autos and Consumer Discretionary more broadly. On the other side, we believe Utilities earnings trends are likely to be very resilient, and Energy and Mining could be supported by better spot commodity prices. What do the potential EPS downgrades mean for the overall market? We believe that bond yields are set to move lower, as per our call from last month to go long duration, and we thought the knee-jerk equity reaction to peaking bond yields is a positive one, but also that this is unlikely to last. The historical correlation between bond yields and P/Es has not been consistent; it was sometimes inverse, as in the past five years, but quite often outright positive - on many occasions P/Es tended to fall, not rise, as bond yields went down. It is the EPS revisions which always displayed a consistent, and positive, correlation to P/E multiples. Over the past year, equities were resilient as EPS momentum improved. If EPS revisions roll over again, as the above drivers suggest, then P/E multiples could roll too.

This podcast was recorded on 20 November 2023.

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