Earnings Revisions Analysis Suggests More Pain to Come

Given the challenging market, I wanted to quickly provide and update on my research. As a reminder, I recently made a hard shift away from my longstanding bullish view in mid-March and I have been pounding the drum ever since on my new unfavorable forecast.

The earnings revisions backdrop, which had been one of my key supports for what was my medium term constructive view, began to weaken during my March deep dive ERM review and the May analysis that was done this week shows that it continues to broaden. 

First, it was only negative inflections, “less good”, but my key proprietary revisions indicator is clearly revealing that the deterioration is spreading, and now more and more names are heading towards the southern hemisphere as accelerating absolute cuts are now beginning.  I have been talking a lot with clients about my expectation that all things cyclical are at risk of estimates cuts going forward that will likely play out over the next 1-3 months, at minimum. 

My work suggests the combination of a hawkish Fed, elevated inflation, slowing growth, rising interest rates, strong USD, continued geopolitical tensions, and an expected analyst profit cutting cycle are creating significant headwinds for the US equity markets. 

With risk premiums also rising, I am reiterating my unfavorable view on equities, and I have said previously if there were a definitive downside price break of 4000 for the S&P 500 that I would target 3600-3500.  Hence, with 4000 having been breached, I am expecting more downside.

Bottom line:  Be careful.  Despite the possibility of an oversold tactical bounce at some point, my key indicators are weakening and nowhere near negative extremes, which suggests considerable downside risk remains.  Based on my work, I have the following conclusions:

  1. The extent of Fed hawkishness and their resolve to stay the course is NOT priced in.
  2. Despite recent equity market weakness and several sentiment indicators suggesting high levels of pessimism, we are NOT near a bottom yet.
  3. The equity decline thus far has been about rising risk premiums, compressing valuation multiples, and the selling of over owned areas and stocks.
  4. A decline based on fears of economic slowing and negative earnings revisions to the forward outlook is only in the early phases.
  5. It is NOT time to shift positioning to the “other” side, and importantly oversold tactical rallies are expected to fail.
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