Cecilia and Jorge R. from Richmond West, FL ask: Hi Mitch, my husband and I saw on the news last night that most investors are expecting very weak profits and earnings this year. It feels counterintuitive to want to own stocks when profits are falling. What are we missing?
Mitch’s Response:
Thanks for your question. Let’s first dig into the news story you saw, which highlighted falling expectations for U.S. corporate earnings in 2023. Wall Street consensus is calling for an approximately -4% decline in aggregate Q4 2022 profits (year-over-year) for S&P 500 companies. This profit decline would be the first since the economic shutdown in early 2020 when the pandemic struck. Consensus goes on to forecast profits declining in the first half of 2023, only to rebound in the second half for a full-year +4% gain.1
Zacks Investment Research has a slightly different outlook for corporate earnings in 2023, as seen in the chart below. We see a bigger decline in Q4 2022 but agree on an earnings rebound in the second half. Regardless, the bottom line remains the same – corporate earnings are expected to be weak in the first half of 2023 with a rebound expected later in the year.
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In your question, you make the point that it feels counterintuitive to own stocks when profits are falling, which based on the above forecasts would mean not owning stocks in the first half of 2023. I understand where you’re coming from – a key objective in owning shares of stocks is to own a portion of future profits and earnings. If those profits are falling, then wouldn’t that be a time to ditch stocks, at least until earnings recover?
While this line of thinking may make logical sense, there’s a problem – the stock market is a discounting mechanism, meaning that the decision whether or not to own stocks does not depend on what earnings will do in the coming quarter or two, but rather where earnings are headed a year-plus from now. If you expect earnings to recover later this year and on into next, then it would make now the time to own stocks, in my view.
By the same logic, investors should consider that last year’s weakness in the stock market was likely driven by a pricing-in of current corporate earnings weakness, several months and even a year before it took place. After all, we know with the benefit of hindsight that expectations for S&P 500 earnings estimates peaked last April (see chart below).
The question now for investors is whether earnings will surprise to the upside in 2023, and whether or not you want ownership in the possibility of a profit rebound later in the year and early 2024. If the answer is yes to both, then it would make now the time to be in stocks, in my view.
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Disclosure
2 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
3 Zacks Investment Research. January 20, 2023. https://www.zacks.com/commentary/2042184/making-sense-of-the-early-q4-results-is-an-earnings-cliff-coming
4 Zacks Investment Research. January 20, 2023. https://www.zacks.com/commentary/2042184/making-sense-of-the-early-q4-results-is-an-earnings-cliff-coming
5 ZIM may amend or rescind the guide “How to Build Your Ultimate Retirement Portfolio” for any reason and at ZIM’s discretion.
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