Profit expectations are still way too high. UBS on what to buy and what to avoid

Published Tue, Sep 27 20222:10 PM EDT

Even after the stock market tumbled into a bear market this year, profit expectations for the S & P 500 remain way too high, which could lead to even more trouble down the road, according to UBS. The S & P 500 is squarely in a bear market, trading 24% below a record set in early January. On Tuesday, it reached a new low for the year. The Dow Jones Industrial Average joined the S & P 500 in bear market territory on Monday, down more than 20% from an all-time high reached at the start of 2022. Year to date, the Dow is down 20%, while the S & P 500 has lost 23%. Stocks have taken a hit this year as the Federal Reserve raises rates to fight inflationary pressures not seen in decades. The U.S. central bank hiked rates last week by 75 basis points (0.75 percentage point) for the third time in a row and indicated that more increases will follow until inflation is subdued. All of this has raised concern over the economy potentially falling into a recession soon. Still, consensus profit expectations for 2023 are elevated, with company margins being the "biggest investor concern," UBS strategist Keith Parker said. He noted that S & P 500 margins on earnings before interest and tax are expected to increase 40 basis points to 17.7% in 2023, with 73% of companies expected to see an increase. Parker thinks these estimates are too optimistic, pointing out out that net margins excluding the energy and financial sectors are down 100 basis points from the highs seen in 2021. Instead, he said that profit growth should be closer to that seen in mid-2019, marking a slowdown in growth compared to the spike seen during the pandemic. With this in mind, UBS put together a list of which stocks investors should buy in this environment. These companies have lower EBIT margin expectations to their pre-pandemic average, but are expected to show strong sales growth in 2023. The list includes snack-and-soda giant PepsiCo . Shares of the Frito-Lay maker are down 4% in 2022, outperforming the broader market. Also included was L3Harris , a defense stock that recently saw shares tick up after Russian President Vladimir Putin announced a partial military mobilization amid the invasion of Ukraine. L3Harris shares are up marginally year to date. UBS also said investors should avoid names with high EBIT margin expectations and slowing sales growth, the reason being that these margins could be in danger going forward. One of those avoidable stocks was S & P Global , which was among firms asked by Senate GOP members to provide more information on how they assign environmental, social and governance ratings to companies . Shares of the financial giant have struggled this year losing about a third of their value. The tech company Nvidia was also included, even though JPMorgan and Citi week said there's lots of upside in the stock . The stock has gotten crushed this year, losing 58%. —CNBC's Michael Bloom contributed to this report.