Over the past few years, the "hotter but shorter" cycle framework has shaped our perception of the markets. The underlying rationale is primarily attributed to the outpour of excess savings accumulated during World War II and the COVID-19 pandemic.
Thus, the constrained money supply during these periods led to unprecedented capital injection into the economy. Both economic fundamentals and asset prices experienced a historically rapid recovery to pre-cycle highs.
Investors and organizations alike may benefit greatly from gaining an understanding of the dynamics of the earnings cycle because of the significant insights it gives about market trends and possibilities. In this article, we explore what has happened so far, but also what to expect next.
Navigating the Earnings Cycle: Assessing the "Bust" Phase
Currently, we are experiencing the "bust" phase of the earnings cycle that commenced in 2020. This dynamic is yet to be factored into the ongoing bear market, which surging interest rates have largely precipitated. Concurrently, we anticipate a sharp contraction in margins and earnings as inflationary pressures subside.
The ensuing period witnessed an inflationary surge and a spike in earnings in 2021. This compelled the Federal Reserve to adopt a more hawkish stance, resulting in the most aggressive monetary tightening in four decades. The magnitude of this economic boom, followed by the Federal Reserve's assertive response, caught many by surprise.
Earnings Projections & Factors Impacting Market Valuations
Adjusting these projections, Morgan Stanley foresees a more pronounced earnings recession, with S&P 500 earnings per share expected to decline by 16% for the year to $185, as opposed to our previous estimate of $195. This impending decline, we believe, has not been fully assimilated into market valuations.
But it is also paramount to acknowledge the tangible prospect for a robust recovery. They maintain the outlook for a significant resurgence in earnings-per-share growth, projecting an increase of 23% in 2024 and 10% in 2025.
Reinforcing this stance, Bank of America's Savita Subramanian said in a recent note, "Earnings are likely to outpace the economy in 2024." Earnings cycles generally precede economic cycles, as earnings tend to rebound with greater vigor than their decline, primarily due to the elimination of superfluous capacity, streamlined cost structures, and enhanced margin profiles during downturns. "The recent drop in [interest] rates and cost-cutting point to potentially a stronger 2024 (also boosted by fiscal stimulus) – historically, earnings recovered faster than they fall.”
Guidance Updates and Sector Performance: Analyzing Expectations for Q1 2024 and Beyond
Among American companies that provided updated guidance, 47% lowered their expectations for the full year 2023, 28% maintained a neutral stance, and only 25% made upward revisions, in line with the research from Allianz.
Nonetheless, positive profit growth is expected in Q1 2024 for nine out of the 11 sectors represented in the S&P 500. Notably, the communication services sector is projected to achieve a year-on-year growth of +20.5%, followed by utilities with +17.7% and industrials with +15.9% earnings per share (EPS) growth rates.
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