November 14, 2023
In our last commentary, we highlighted that corporate earnings are a fundamental driver of equity markets. We further discussed the cyclicality of earnings and how earnings tend to move in the same direction as the US economy but in greater magnitude. We thought it would be prudent to dig deeper into the direction of earnings growth.
We have developed a model that tracks trailing earnings growth for the S&P 500® Index. The green line in the chart below shows a slight decline in 12-month trailing earnings on a year-over-year basis through October of this year. The most recent decline was not as severe as our model predicted, represented by the blue line. Regardless, our model suggests that corporate earnings will continue to weaken, while consensus estimates for earnings point to a rebound. In other words, our model is in line with our view that a recession remains likely. In contrast, the consensus view anticipates a soft landing.
If earnings deteriorate further, markets will need to see price-to-earnings (P/E) multiples rise to offset the decline in earnings. However, as we have noted in the past, P/E multiples typically fall during a recession. Equity investors may have to come to grips with a deteriorating outlook if corporate earnings eventually move in the direction we believe they might.
Trailing corporate earnings growth: S&P 500 Index*
Year-over-year % change
* The dotted green line represents consensus trailing earnings per share (EPS) growth estimates. The dotted blue line represents forecasted values from our trailing EPS growth model.
** The trailing earnings growth model includes the following indicators: ISM Manufacturing Orders, lending standards, and the 10-year US Treasury yield and federal funds rate.
Note: Shaded areas of chart indicate recessionary periods.
Sources: Macrobond, S&P Global, The Conference Board, Institute for Supply Management (ISM), US Census Bureau, National Association of Home Builders, Federal Reserve Bank of New York, US Department of the Treasury, US Department of Labor, US Federal Reserve.
Chart is for illustrative purposes only.
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