Coming Soon – 2023 Earnings!

As this tumultuous year comes to a close, investors have already started shifting their attention to next year’s outlook. Earnings estimates have been a hot topic over the past 12-18 months, and we would expect that to remain the case given the heightened level of uncertainty in financial markets and the broader economy. Simply put, the greater the uncertainty, the more likely it is to see revisions to earnings estimates.

As seen in the chart below, earnings estimates have been steadily declining in recent months. From the respective peaks, 2022 earnings have been revised down by about 4%, while 2023 and 2024 estimates have come down by 8%. This is important because the price-to-earnings (P/E) multiple that investors thought they were paying just a few months ago turned out to be higher than anticipated.

It is easy to understand why earnings estimates have been coming down. Remember, the analysts who make these forecasts are always looking ahead several months into the future. Once it became clear that the Federal Reserve would be forced to raise interest rates higher than what was forecasted at the start of the year, earnings estimates came down in short order.

As we sit here today, the consensus estimates provided by Factset indicates that S&P 500 earnings will increase by 5.5% in 2023, followed by a 10% increase in 2024. For perspective, this compares to the long-term growth rate of 6-8% and the trailing 10-year average of 8.5%. The quarterly earnings growth for 2023 according to Factset is as follows: 1.1% in 1Q, 0.6% in 2Q, 6.4% in 3Q, and 10.4% in 4Q. The back-half weighted cadence is a bit disconcerting since most companies will not provide their 2023 earnings outlook until early next year. We would not be surprised to see management teams take a cautious approach when providing 2023 guidance, which could lead to further earnings revisions. 

The graph below shows that analysts are expecting eight of the eleven sectors in the S&P 500 to deliver positive earnings growth in 2023, led by Consumer Discretionary, Financials, Industrials, and Communication Services. If we were to exclude Consumer Discretionary, we estimate that the earnings growth rate for the S&P 500 would fall from 5.5% to ~2%. On the other hand, the Energy sector is expected to see the steepest year-over-year decline in earnings after growing by nearly 160% in 2022. If we were to exclude the Energy sector, we estimate the S&P 500 earnings growth would be just over 6% in 2023.

The key takeaway from all of this is that the current earnings outlook appears to be highly dependent on the assumption that the Fed will successfully pull off the elusive soft landing. As it currently stands, the sectors that are expected to drive most of the earnings growth in 2023 are more economically sensitive and thus are more vulnerable to earnings revisions. Given this uncertainty, investors should prepare for a range of outcomes. In the matrix below, we show the potential year-end 2023 S&P 500 index level and corresponding returns compared to the current level of 3,895 (as of the close on 12/15/22). The range of earnings estimates represents plus or minus 10% relative to the current consensus earnings estimate of $230.

It is times like this where quality is of utmost importance. We continue to favor a diversified portfolio with companies that have resilient balance sheets, experienced management teams, and the ability generate strong cash flows in both good times and bad. Hang in there, and happy holidays!