The stock market's biggest risk in 2023 is a drop in corporate earnings, even if the economy avoids a recession
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- The stock market's biggest risk in 2023 is a decline in corporate earnings, according to Ned Davis Research.
- NDR said even without a recession, profit margins could fall if "wages prove to be sticky."
- "The direction of earnings revisions is likely to be down regardless of whether Powell can find some of Greenspan's 1994 soft-landing magic."
The stock market's biggest risk in 2023 is the fact that consensus earnings estimates are way too high, and they're likely to fall even without an economic recession, according to Ned Davis Research.
Consensus estimates expect a 14% jump in S&P 500 operating earnings per share, NDR strategist Ed Clissold highlighted in a note last week.
If corporate earnings estimates get downgraded, as NDR expects, then stock prices should follow as investors grow concerned about lower profits and a potential recession. And that potential earnings drop is the big risk to investors even after a significant down year for the market in 2022, with the S&P 500 falling 20% year-to-date.
"The direction of earnings revisions is likely to be down regardless of whether Powell can find some of Greenspan's 1994 soft-landing magic," Clissold said.
Already investors are growing concerned about a surprise earnings miss from mega-cap companies like Apple and Tesla, as ongoing COVID infections in China impact the production of their flagship products.
But what's bound to hurt corporate profit margins for companies of all different sizes is wages if they "prove to be sticky," NDR said, as labor represents the biggest cost for most companies.
"Employees know their paychecks do not stretch as far as in years past, so many will be looking for wage increases, even if the labor market cools. If overall inflation falls below unit labor cost growth, then margin pressures could intensify," Clissold said.
In a non-recession scenario, NDR estimates that earnings revisions "in the ballpark of 8% would be a reasonable assumption." In that scenario, S&P 500 profits would still have a chance of growing by the end of 2023.
But the profit decline could get much worse in the event that a recession hits the US and slows down consumer spending and the economy, with NDR highlighting that earnings drop 24% on average during recessions.
"If the economy falls into a recession, [earnings] revisions could be the biggest since 2020 COVID-19 shutdown and possibly larger than during the 2015 oil collapse," Clissold said. "Unless economic conditions improve quickly, earnings revisions could be severe."
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