Published September 13th 2022

Daily Brief - Corporate margins are crashing


Right on cue, the TLI turned a week before last Friday to signal that the downturn in markets has temporarily come to an end. However, there are more structural headwinds investors now have to contend with as Fed tightening begins to rein in the economy. The most imminent one? Declining earnings expectations.

In another one of his outstanding blogs, John Auters highlights this issue much more eloquently but we’ll summarize it here (we highly recommend his blog, and it’s free).

bloomberg chart
Source: Bloomberg, via John Auters blog

S&P 500 earnings estimates for 2023 have been falling in recent weeks and those for next year have taken a bigger hit. They are down from the midsummer peak. The picture looks even more dramatic if energy stocks are taken out of the picture.

Why is this happening?

One word: margins are crashing. Of course, there is other stuff happening, too but whilst the economy remains relatively stable, corporate bottom line has taken a big hit from rising prices. They are passing it on but the inflationary shock was so rapid, they’re playing catch up only gradually to avoid alienating their customers.

declining profit margins
Source: Societe Generale, via John Auters blog

Time to sell, then?

The relationship between earnings and stock prices is complicated in the short run. Earnings fell more than 30% in 2020 yet the S&P 500 actually rose 18%. Or when earnings were up 20% in 2018, the stock market fell more than 4%. In 2015, earnings were down more than 15% yet stocks finished the year up nearly 2%. (Remember the Warren Buffet quip that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.)

The earnings growth smile

Excellent analysis from Ned Davis summarized in this chart found that, by and large, market trends were mostly impacted at extremes: strong earnings growth was best for stocks, and extremely weak growth derailed a bull trend.

However, slightly negative or mediocre earnings growth wasn’t historically enough to derail a rising market trend.

Update: NIO missed earnings

Last week we highlighted how NIO has historically performed after missing expectations

Projections (2).jpg

After reporting on Wednesday morning, the stock is up more than 15%. Nice one TOGGLE! 🤜 🤛

KK Scratch (6).png

Idea Spotlight: Southwest

Equity yield indicators for LUV:NYSE reached a recent high and historically, this led to a median increase in price of 27.28% over the following 6M. TOGGLE analyzed 12 similar occasions in the past to produce the median projection and this insight received 6 out of 8 stars in our quality assessment.

Spring is a peak travel season. To accommodate this, Southwest is rolling out new nonstop flights during this travel season to popular destinations in Mexico and the U.S.

southwest price history

Daily Brief - Corporate margins are crashing

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