Morgan Stanley cuts further EPS forecasts
Analysts lower SPX price target to 3,400; recession target to 3,000 in 2023
1H22 was challenging for most risk assets as the Fed started hiking rates due to inflation threats. The de-rating for US stocks was punctuated by a brief growth scare in June, although valuations never reflected the true risk to earnings.
Morgan Stanley strategist Michael Wilson cut his expectations for EPS growth for the year, saying that a slowing economy is now likely to be a bigger concern for stocks, rather than scorching inflation and a hawkish Federal Reserve. In 2023, he expects earnings to fall 3% even in the absence of a recession.
The US bank sees downside US earnings amid growth jitters; see some key concepts from their Tuesday report.
Fire and Ice has proven to be an effective way to describe the first half of this year. Fed tightening in response to historically high inflation, the Fire, has weighed heavily on valuations for all asset markets. Meanwhile, growth has also disappointed...the Ice. While this combination proved challenging for most stocks, we think part 2 will turn out to be more Icy than Fiery as slowing growth becomes the bigger concern for stocks, rather than inflation and the Fed.
While acknowledging the poor performance in equities year-to-date, we do not think the bear market is over if our earnings forecasts are correct. More specifically, we think the lows for this bear market will likely arrive in the fourth quarter with 3,400 the minimum downside and 3,000 the low if a recession arrives (in line with our well established base and bear case tactical views, respectively). From there, we think prices will recover to our base (3,900) or bear (3,350) case June 2023 targets. In the very near term, if back end rates fall, stocks may hold up or even rally until later this month when QT potentially increases and earnings estimates are likely revised lower.
We Revise Our EPS Forecasts Lower
We make downward revisions to our earnings forecasts as our leading models point to continued and increasingly significant EPS growth downside well into 2023. Specifically, we revise our 2022 base case EPS estimate to $220 from $225 (down 2%), our 2023 base case estimate to $212 from $236 (down 10%), and our 2024 base case estimate to $226 from $237 (down 5%). Our 22/23/24 base case estimates are now 3%/13%/14% below consensus, respectively. In our base case, 2023 now marks a modest earnings contraction (-3% year-over-year growth), though we do not embed an economic recession in this scenario. The logic here is that nominal top line growth slows, but remains positive (mid-single-digit territory), while margins contract materially (1-1.5% margin compression) driven by sticky cost pressures, particularly on the labor side.
We revise our ‘23 bear case EPS modestly lower to $190 from $195. This case continues to assume an economic recession (consistent with views published in our mid-year outlook), and implies an 11% year-over-year EPS growth contraction. Our ‘23 bull case EPS forecast also comes down to $234 from $245. In this scenario, nominal top line is slightly better and margin pressure is Less significant when compared to our base case.
Our June 2’3 price targets do not change, and EPS downside is offset by modest upside in PIE multiple expectations. We remind readers that these price and multiple expectations are point in time, June 2023 estimates. By that point, equities will be processing the growth path into 2024 (a reacceleration, in our view), not the decelerating growth path into 2023 that's in the rear view. As such, the call for price downside as a result of declining EPS into mid-2023 — the basis of this note, and a high conviction view — is very much a tactical view (next 3 months). To further reinforce this point, we note that the market multiple typically troughs when EPS is only a third of the way through its decline (i.e., price front-runs EPS declines).
Our base case tactical view remains that fair value price for the S&P 500 is around 3,400. We would expect to reach that price level before year end and then work back toward 3,900 by mid next year. As previously noted, we think tactical fair value in our bear case (an economic recession) is 3,000, which implies an overshoot to the downside of our June ’23 bear case price target in advance of that date.