Man, what a mess. Earnings in 2022 are all over the map. There are big winners, like oil companies, and some potential losers, like financials and consumer discretionary names. Most importantly, because of the uncertainty around the Federal Reserve, inflation and the Russian invasion of Ukraine, guidance is in desperately short supply — and that is the lifeblood of Wall Street. As a result, confusion abounds. First-quarter earnings: The big winners and losers Overall earnings for the first quarter are expected to be up 6.4%, according to Refinitiv, almost unchanged since the beginning of the year. However, there is an unusually wide dispersion in profits among several sectors, with energy being a big winner, and financials and consumer discretionary as notable losers. Energy: This is the big winner in the profit sweepstakes. As oil has gone from $75 per barrel at the start of the year to more than $100, and natural gas has almost doubled, earnings estimates for oil and gas companies have skyrocketed — from up 165% on Jan. 1 to up 240%. The problem for the market is that energy accounts for only 3% of the S & P 500 , so many investors have little exposure. Financials : Financials have the worst profit expectations of any sector, estimated to be down 18.9%. The main reason for this is that many large banks have already reported and, as analysts feared, many have announced they are building reserves to provide some cushion against a potential slowdown in the economy and an increase in defaults. Consumer Discretionary: Another sector with expected earnings declines (down 12.7%). This includes retailers, apparel, home improvement, homebuilders, automotive manufacturers and restaurants — all of which are dealing with higher labor costs and supply chain issues that are pressuring profit margins. The issue is the guidance: It's unusually murky As always, it's not about the numbers being reported, it's about what CEOs are saying about future business. The two issues obsessing analysts and investors are 1) will the Fed's aggressive rate hikes induce a soft landing, or a recession?, and 2) what is the impact of inflation on profit margins? Unfortunately, CEOs have been unusually quiet, leaving analysts alone with their spreadsheets. The stock market, however, has not been silent, and has been in a frenzy of speculation about whether a recession in 2023 is imminent. It didn't help sentiment that one of the few CEOs to comment on the outlook recently, RH CEO Gary Friedman, sounded a bit apocalyptic on his earnings call a couple weeks ago, saying: "We have experienced softening demand in the first quarter that coincided with Russia's invasion of Ukraine in late February and the market volatility that followed. We believe it is prudent to remain conservative until demand trends return to normal." Fair enough, but he went well beyond that, saying he has "never been more uncertain" in his 22 years at RH. He also questioned the sustainability of the housing market and said that "you've got inflation like I've never seen." That got people all stewed up about recession worries. The result of this is that Wall Street will be obsessed with any indication of a softening in demand. Margin pressure continues: How bad will it get? Fortunately, margin pressure is far more easy to quantify than a recession projection. The good news is that, despite supply chain and other inflation problems, net profit margins have remained high by historical standards, hitting a record 13.1% in Q2 2021. The bad news is that margins are expected to slip to 12.1% for Q1 2022, which would be the third straight quarterly decline. S & P 500: net profit margins eroding? Q2 2021: 13.1% (record) Q3 2021: 12.9% Q4 2021: 12.4% Q1 2022 (est.): 12.1% Source: FactSet A bit more good news: These numbers, while weaker, are still above the five-year average of 11.2%. The margin declines are being driven by higher costs. Producer prices increased by 11.2% in March, which was the largest year-over-year increase on record . However, revenues are up because companies are raising prices to offset higher costs. The S & P 500 is expected to report revenue growth above 10% for the fifth straight quarter. That is well above historic averages. If corporations can raise prices, why are so many strategists gloomy on the profit outlook? This all sounds like good news. However, sell-side analysts — who cover individual stocks — are making very optimistic assumptions about earnings and the ability of corporations to maintain that pricing power, and that is the weak link in the argument. Strategists are doubtful that corporations will continue to have pricing power if inflation persists. Q1 is expected to be the low for the year for both earnings and profit margins. Both are expected to rise for the next several quarters: 2022 earnings estimates are steadily rising Q1: $51.30 Q2: $55.85 Q3: $59.29 Q4: $60.89 Source: Refinitiv 2022 S & P 500 net profit margin estimates bottoming? Q1: 12.1% Q2: 12.7% Q3: 13.1% Q4: 12.8% Source: FactSet While sell-side analysts remain optimistic for margins and earnings for the rest of the year, strategists —who focus on broader, macro trends in the economy and then extrapolate earnings from those macro trends — are not as optimistic. Savita Subramanian at BofA Global Research said the expectation that profit margins will again hit new highs "we believe is overly optimistic and continue to see downside risks to consensus earnings." Goldman Sachs' David Kostin flatly told clients: "We expect negative revisions to 2Q-4Q EPS estimates." He said that's because "analysts appear reluctant to adequately trim forecasts despite the high degree of uncertainty surrounding the economic outlook." Kostin's own estimate of 2022 earnings are 3% below Street estimates, and he doesn't expect the first quarter commentary to clear up the mess: "We believe results from 1Q earnings season are unlikely to generate enough clarity for analyst estimates to fully converge to our forecast." Has inflation peaked, and is it going to stay at high levels? There's high anxiety among investors because earnings are largely dependent on the glide path for inflation, which is currently unknowable. Hence the uncertainty. Some are hopeful that inflation is beginning to peak and are arguing that tech valuations will begin improving. "We see that data as very positive as evidence of easing inflation, which we expect in coming months," UBS strategist Stuart Kaiser said in a note to clients on Monday. Nick Raich from The Earnings Scout correctly framed the central issue in a recent note to clients: "We care less about whether inflation has peaked and more about how long it will be sustained." "We have no doubt the Fed will be able to curb inflation by raising interest rates and via QT [Quantitative Tightening]," he added. "The problem is the central bank could easily cause growth to decelerate more than anticipated in the process." And that much-feared recession, what would it do to stock prices? Citigroup strategist Scott Chronert is perhaps representative of the consensus. "A mild recession in 2023 could lead to roughly -20% index downside, while continued Fed tightening to stave of persistent inflation against an already weakening economy could led to a more severe -30% drawdown," he said in a note to clients.
Traders buy and sell shares on the floor of the New York Stock Exchange (NYSE) in New York City, April 14, 2022.
Brendan McDermid | Reuters
Man, what a mess.
Earnings in 2022 are all over the map. There are big winners, like oil companies, and some potential losers, like financials and consumer discretionary names.