Stocks Face a Dangerous Earnings Surprise

Stocks Face a Dangerous Earnings Surprise
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Wall Street experts have just marginally reduced their overly rosy earnings projections, but they are still a long way from accepting the possibility of a recession. That makes the market particularly vulnerable if other businesses cut their own forecasts in response to FedEx Corp.’s decision to drop its earnings projection. This may leads to Stocks Face a Dangerous Earnings Surprise.

 

The move made by FedEx late on Thursday caused its shares to plunge to their lowest level since 1980 and came amid a rising gap between analysts’ earnings estimates and the macroeconomic outlook, which is largely influenced by the signals that firms give about their futures. This may leads to Stocks Face a Dangerous Earnings Surprise.

Will the Recession occur ?

A recession in the US is now expected to occur within the next 12 months, according to the median analyst surveyed by Bloomberg, up from a 33% risk in mid-year. Economists worry that the labor market and resilient spending trends will ultimately suffer as a result of the Federal Reserve’s efforts to control the worst inflation in 40 years. Even while the economy hasn’t yet collapsed, the hard numbers indicate that it will eventually, and equities have little chance of being spared.

 

A probability-weighted approach would have traders betting on single-digit earnings declines in the next 12 months, but the market isn’t quite there yet. Even if you split the difference between the mildly optimistic and the mildly pessimistic — 50% odds of the Wall Street status quo with ho-hum earnings growth, 50% odds of a mild recession — the market isn’t quite there yet. Recessions historically have also been accompanied by lower forward P/E multiples than the present 16.5 times. However, it’s obvious that market pricing continues to lean toward the optimistic side of the earnings spectrum even if you use a reasonably generous multiple. There are likely fewer avenues higher than the S&P 500’s June low of 3,667 than there are to break through it, as the following table illustrates.

S & P and FedEX Outlines

Even after taking into consideration the S&P 500 Index’s 4.8% down last week, markets seem to be buying this optimism to a significant level, so it’s not only the analysts who are upbeat. The S&P 500 earnings yield, which is the inverse of the P/E ratio and the ratio of predicted EPS to price, has been consistent throughout the year and suggests that Treasury yields are what are actually moving the market.

Prior to the next Fed monetary policy decision on Wednesday, when policy makers are anticipated to boost the upper bound of the fed funds rate by 75 basis points to 3.25%, the FedEx news had the market on edge. Despite the economy’s resilience, the infamous “long and varied delays” of monetary policy are certain to bite at some point in the near future, and the equities market appears to be ill-prepared for what is to come. None of that means that the US is heading for some kind of 2008-style earnings calamity, but you don’t have to believe that to acknowledge that the market looks overly sanguine. The FedEx development may well be the first in a series of catalysts that help traders realize that.


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