Falling Shoes

Strategists have been cautioning about a pending earnings collapse


Despite rising inflation and the Fed’s attempt to combat it with rising rates, the economy, and corporate earnings have not deteriorated in a meaningful way (yet). For the past several weeks, the financial press, and Wall Street strategists have been raising concerns that corporate earnings are subject to decline.


While the global tightening cycle dominated the bearish narrative in Q3, another big overhang on risk sentiment seemed to be concerns that earnings could be the next shoe to drop. Morgan Stanley was particularly vocal on this front, arguing that consensus estimates are too high given the combination of demand destruction, margin pressure and a stronger dollar. – Commentary provided by StreetAccount 9/30/2022


From our vantage point the shoes may be dropping soon. With the third quarter earnings season about to begin, we will use sell-side analyst estimate data as a proxy for future earnings.


We watch analyst revisions carefully at Jackson Creek, as they are important inputs to our quantitative models. Our data, looks at the ratio between the number of increased estimates compared to those lowered. The large cap universe begins with the Russell 1000 and filters out companies that do not meet liquidity, analyst coverage, capitalization, and share price thresholds.


Back in July, we pointed out how EPS revisions were trending lower. Here, we provide the same chart, updated for the most recent quarter ended September 30th, with added historical perspective. Analyzing earlier trends is by no means a crystal ball but can provide context to the current cycle.


Large Cap net earnings revision ratio

Source: Jackson Creek Investment Advisors; S&P Global


As the chart depicts, analyst sentiment ebbs and flows each quarter. Since 1996, positive sentiment has ranged from about 40% (net negative) to about 60% (net positive) with an average of 51% - slightly net positive. As of September’s end, the positive revision ratio was 43%. It has been declining since positive analyst sentiment reached a new high in June 2021.

Sharp positive and negative moves occurred in past cycles. Prior to the pandemic, the ratio was in decline since its earlier high in March 2018. The positive ratio was below the average for five quarters prior to the March 2020 bottom.


The greatest pessimism occurred in the fourth quarter of 2008, during the Financial Crisis. The peak prior to that was back in June 2004. The chart shows it was not a steady decline. Sentiment improved in several interim periods (including the second quarter of 2008) even though the longer-term trend was downward. Interestingly, the rebound from December 2008 to the next peak in December 2009 was faster than the post-pandemic rebound.


The current revision ratio is negative and trending down. If history is any guide, we may have to endure further declines as the ratio has yet to match prior troughs. The most recent cycle from 2018-2020 lasted eight quarters from peak to trough. Prior to that, there was almost five years between the peak in 2004 and the bottom in 2008. As of the end of September, we are only five quarters removed from the June 2021 peak.


It will be telling to see how this earnings season unfolds. If companies are unable to meet the lowered estimate bars, it could spell trouble for future sentiment and revisions. The shoes will finally be hitting the ground.

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