Two “Data” items today:
Topic #1: Wall Street analysts’ Q1 2022 earnings expectations for the S&P 500. Earnings season begins in just over 2 weeks here in the US. Also, there is no FOMC meeting in April (the next one is on May 4th) so earnings will have a shot at holding the market’s attention through the month.
This chart shows just how much Q1 2022 earnings matter to stock prices. Analysts’ estimates for the quarter (black line) have gone nowhere since September 2021 and neither has the S&P 500 (blue line). Estimates were on a modest uptrend through December 2021 (just visible in that small blip to a high of $52.25/share) but have come down since then. The causes for that decline? First came worries about slow Q1 US GDP growth (just 1-2 percent), with Russia-Ukraine following on along with higher oil prices after that.
Now, it’s not that stock valuations really hinge on just one quarter’s results, but rather that markets are concerned Q1 2022 will show there’s nothing left to the growth story for US corporate earnings. Here is the progression of S&P 500 earnings per share by quarter from the June 2020 lows:
- Q2 2020: $28.25/share
- Q3 2020: $39.40/share
- Q4 2020: $42.30/share
- Q1 2021: $49.09/share
- Q2 2021: $52.80/share
- Q3 2021: $53.88/share
- Q4 2021: $55.37/share
- Q1 2022 (E): $51.85/share
Takeaway (1): the companies of the S&P 500 must beat Wall Street consensus by an average of 8 percent during the upcoming earnings season just to print $56/share in Q1 EPS and show the most meager of sequential earnings growth (1 percent versus Q4 2021). The typical beat percentage is more like 6 percent, so that’s quite a stretch.
Takeaway (2): we do believe that the S&P 500 can print at least a $55/share Q1 result (flat to Q4 2021) and US corporate earnings power and free cash flow generation will remain strong in 2022, but what’s the right PE multiple for flat earnings? As of Friday’s close, the S&P 500 trades for 20.6 times $220/share in current earnings ($55/share times 4 quarters). On the bullish side of things, valuations should be higher than the usual 17-18x because free cash flow is strong and that allows for higher levels of stock buybacks. More concerning, it is still hard to justify a +20 multiple for what could be top of cycle earnings.
Topic #2: Let’s talk about 50- and 75- basis point rate increases at Fed meetings, because that’s what Fed Funds Futures say is coming down the path:
- April 4th FOMC Meeting: 73 percent odds of a 50 basis point rate hike, up from 44 pct odds a week ago.
- June 15th FOMC Meeting: 62 percent odds of a 50 basis point rate hike and 17 pct odds of a 75 basis point rate hike. Odds for these outcomes were 35 and zero percent a week ago.
Now, consider the following:
- The last time the FOMC raised Fed Funds by 50 basis points at a single meeting was back in May 2000. That was the last step of a tightening cycle that had begun in June 1999, with the prior moves (5 of them) at just 25 basis points each.
- The last time the FOMC raised Fed Funds by 75 basis points at a single meeting was in November 1994. This was the penultimate increase of the 1994 – 1995 rate cycle, preceded by three 25 basis point hikes and then 2 50 basis point increases. The last move of the sequence was in Feb 1995 with a 50 basis point bump.
On a related note, here are the odds implied by Fed Funds Futures for February 2023 (longest timeframe for which the CME FedWatch tool has data). The odds that the Fed will have taken short term rates to over 2.5 percent by then stand at 79 percent. The problem is that 10-year Treasuries only yield 2.5 percent today, so expectations of Fed Funds above that level imply an inverted yield curve (a signal of impending recession).
Takeaway: as much as it is entirely understandable why the Fed must move quickly and with conviction on rate hikes, it is important to understand that there is little historical precedent for starting a rate cycle with 50 or 75 basis point increases. If US monetary policy does develop as markets expect, the Fed would be relying on the domestic economy being able to take outsized rate hikes and only cool rather than stumble. We continue to see the yield on 10-year Treasuries as the market’s litmus test for that assumption. Yields here need to continue to rise (and we expect they will); at present they are modestly lower than the market’s take on future Fed policy, signaling the possibility of a recession.
History of Fed rate decisions, 1990 – present: https://www.federalreserve.gov/monetarypolicy/openmarket.htm