Outlook Update, 3Q22 Earnings Preview - Transcript

Welcome to RBC’s Markets in Motion podcast, recorded October 13th, 2022. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

Today in the podcast, updated thoughts on our outlook for the US equity market as well as what’s coming up in 3Q22 reporting season. 

Four big things you need to know: First, we are trimming our S&P 500 EPS forecasts, which were already well below consensus, taking 2022 to $216 (down from $218) and 2023 to $208 (down from $212). Second, we are cutting our year-end 2022 S&P 500 forecast to 3,800 (down from 4,200) and issuing a new, preliminary target of 4,100 for 2023. We expect conditions to remain choppy over the next few quarters but anticipate recovery in 2023 as a whole. Third, 3Q22 reporting season has gotten off to a rough start in terms of stats and tone. The good news is that stocks tend to bottom ahead of the end of the downward earnings revision cycle and concerns about inflation and supply chains as well as expectations regarding pricing may have peaked. Fourth, Small Caps were the star of the show in 2Q22 reporting season, which helped stabilize performance vs. Large Cap. If this happens again, it could help trigger a new phase of Small Cap leadership.

If you’d like to hear more, here’s another 5 minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify, and other major platforms.

Now, the details.

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Starting off with Takeaway #1: we are trimming our S&P 500 EPS forecasts, taking 2022 to $216 (down from $218) and 2023 to $208 (down from $212).

  • Generally, we are baking in a weak GDP backdrop through the end of 2023 with the most acute pressures seen in 4Q22 and 1Q23. We also have headline inflation ramping down to just under 3% by year-end 2023, moderating commodity prices, a significant step-up in interest expense…

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  • … a meaningful contraction in operating margins, and little benefit from share buybacks.

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  • This as mostly a housekeeping move, updating our model for changes in macro assumptions like GDP, CPI, and commodities.
  • We’ve been well below consensus since July when we made much bigger cuts to our numbers.
  • Consensus is still tracking at $225 for 2022 and $240 for 2023.

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Moving on to Takeaway #2: we are cutting our year-end 2022 S&P 500 forecast to 3,800 (down from 4,200) and issuing a new, preliminary target of 4,100 for year-end 2023.

  • Similar to how the stock market traded in 2002-2003 and 2010-2011 when we got a triple bottom, we expect conditions to remain choppy over the next few quarters. We anticipate recovery in 2023 as a whole, but see that as a back end loaded view.

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  • Our targets are essentially the average of the outputs from 7 different economic, earnings, sentiment, valuation, political, and cross asset models that we regularly use.

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  • Importantly, they do bake in the idea that we’ll see Republicans take back at least one chamber in the midterms next month.
    • Typically in mid-term election years, the S&P 500 bottoms in October and rallies back about 7% by year-end. That plays into our late 2022 view.

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  • Thinking ahead to 2023, it’s worth noting that the S&P 500 tends to see gains of 13-14% in years that have a Democratic President and Republican or Split Congress.

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  • I won’t go through all of the models and back tests the go into our targeting process here. But the one other piece of analysis that we’d call your attention to is our valuation model.
    • It bakes in expected trends in inflation and interest rates, leveraging data back to the 1970’s. And anticipates a P/E of around 16.59x at the end of 2022, but some modest expansion into the low 20’s by the end of 2023. That notion plays into our call that stocks can stage a recovery next year, even with our below consensus EPS forecast.

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Moving on to Takeaway #3: 3Q22 reporting season has gotten off to a rough start in terms of the stats and the tone.

  • In terms of the stats for the S&P 500, we’re seeing fewer beats so far for 3Q – a trend already underway in 2Q reporting season….

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  • …and misses are getting punished hard…

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  • …we’ve also seen the return of downward revisions on the sell-side, but those cuts don’t seem deep enough just yet. We think that probably won’t get taken care of until January and February when companies issue 2023 guidance and the sell-side reacts with their own forecast adjustments.

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  • In terms of tone, there’s been a clear deterioration in management tone in survey data on everything from the economic outlook, to demand, capex, and employment…

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  • … and in our transcript review, we’ve also noticed that commentary on currency headwinds, layoffs, and uncertainty has been on the rise but remains well below past peaks.

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  • One bit of good news on the data side is that the stock market does tend to bottom well ahead of the end of the downward earnings revision cycle – typically we see the S&P 500 bottom 3-6 months before the downward revision cycle is complete.

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  • Another bit of good news on the tone –on our transcript tracking analysis commentary on inflation and supply chains and pricing appears to have peaked. That’s very good news from an inflation perspective.

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Wrapping up with takeaway #4: Small Caps were the star of the show in 2Q22 reporting season and we’ll be watching to see if this can be repeated.

  • The Russell 2000 actually saw a pick up in the percent of companies beating consensus for 2Q, while Large Caps saw fewer earnings beats.

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  • Small Caps also saw more upward revisions to earnings forecasts than Large Caps over the summer, something we hadn’t seen in quite some time. Currency and lower international revenue exposure likely played a role in this.
  • Overall, a better earnings profile helped Small Cap performance stabilize relative to Large Cap in recent months. And if Small Caps look like the better choice from an earnings perspective this time around, it could help trigger outperformance in a part of the market that already appears to be fully baking in a recession.

That’s all for now, thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for thoughts on specific sectors from RBC’s team of industry analysts.