A case for a 30% decline in the S&P 500

“For 2023, the bottom-up EPS estimate for the S&P 500 is $232.53…….
industry analysts on average have overestimated the final EPS number by 7.0% one year in advance.”

This article talks about the overconfidence of analysts estimates and the chart within shows the record setting levels the annual EPS have reached.

I have been wanting to write about how EPS have been assisted by declining interest rate expenses and lower corporate tax rates.

Instead, I’ll reference this paper written by Smolyansky, Michael (2022). “The coming long-run slowdown in corporate profit growth and stock returns”

https://www.doi.org/10.17016/2380-7172.3167

He cites, “Both these items accounted for 33% of all profit growth for S&P 500 non-financial firms over the prior two-decade period”.

The Tax Cuts and Jobs Act of 2017 reduced the statutory corporate tax rate from 35% to 21%,
Interest Rates and therefore the cost of capital has been at its lowest in history,
While, corporate leverage grew by 40% over the past 10 years,
And globalisation provided lower input costs.

It was the perfect recipe to juice up the profits.

But the ingredients of that recipe has changed.

Now, when the cost of capital has doubled and nearly tripled,
debt leverage hasn’t been reined in by any notable measure,
local on-shoring is being favoured over the political football of globalisation
and government may potentially look at higher taxation to increase revenues…..

There is no way that the S&P 500 will earn $232 per share in Calendar Year 2023 or even an average adjusted figure of 7% lower.

Going into 2022/2023, U.S. corporations have had it as best as it has been.

Today, with a S&P 500 Index trading at 4,000 and using a $232 per share forward earnings estimate means that the P/E Ratio is 17.2.

This doesn’t seem like an economic environment which neither inspires record earnings (let alone 12% higher than recorded 18 months ago) and a market which I want to pay 17 times earnings for.

Perhaps I want to pay 14.6 times earnings for companies within a mid-cycle slowdown (or a GDP recession) and maybe I think the S&P 500 will earn $192 per share.

Then the S&P 500 touches 2,810

I’ll play around with a few other guesses but my suggestion is to watch how corporate EBIT changes when the (I) interest and (T) taxes start rising.

December 6, 2022
by Rob Zdravevski
rob@karriasset.com.au