Earnings Season and Market Multiples

Over the last few weeks, recession fears have been so strong that markets are expressing these fears no matter what central banks say. The Treasury bond market also flashed another warning signal this week as yields on U.S. government bonds inverted for the third time this year.

High inflation and monetary tightening are headwinds that could continue to pressure markets in the near term, and the market is increasingly pricing in a potential recession. This could negatively impact profit and revenue growth for most stocks as earnings season kicks off this month. Despite a good start so far this quarter, it is possible that the S&P 500 and the market overall will continue to pull back in the coming weeks and months.

However, there are also some positive signs when it comes to the longer-term outlook. Valuations have pulled back quite a bit and the broad market is no longer priced at a significant premium relative to historic valuations. Based on current consensus estimates, the S&P 500 is forecasted to earn $215 in 2022 and around $235 in 2023.

Relative to the current index level, that means that the index is valued at 18 times this year’s profit today. The earnings multiple for 2023 is 16.5, which calculates an earnings yield of slightly above 6%. These are not absolute bargain valuations, but they aren't especially high valuations either. Contrast this with an index level of 4,800 and earnings of around $200 in 2021, which made for an earnings multiple in the high 20s. 

With a high-teens earnings multiple for 2022, valuations seem relatively reasonable and are not necessarily historically high. Of course, it is possible that the S&P 500's earnings will come in lower than expected, raising multiples, and pushing prices further to the downside. Market multiples may also continue to be pressured by inflation alone as the Fed continues to pull liquidity out of the credit and capital markets.

There are some signs that inflation might moderate in the coming months, as a couple of key commodities have recently started to pull back from this year's highs. Copper and oil are both down from the highs hit earlier this year. The same holds true for steel and even some agricultural commodities. This might ease inflation and would thereby allow for a better outlook when it comes to the nature of monetary restraint and consumer spending.

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