Why stocks could still face a 1980s-style decline

A “significant decline” in corporate earnings that has yet to be factored into US stocks could still trigger a sharp decline that could rival the 30% decline of the 1980s, Principal Asset Management warned in a new outlook.

“Gross margins are under threat, not only from difficult financial conditions and hawkish banks, but also from tight labor markets,” Principal’s asset allocation team wrote in its first-quarter outlook.

“With such strong wage growth and growing consumer concerns, corporate profit margins are being squeezed on both sides,” the team said. “Earnings growth is under great pressure.”

While the S&P 500 index SPX,
lost nearly 20% last year, its worst year since 2008, its EPS metric has held up (see chart) better than previous pullbacks of at least 10% since the 1960s.

The S&P 500 EPS pullback isn’t happening yet

Bloomberg, the main asset management

EPS refers to net income divided by the number of shares outstanding, which shows how much money a company makes for each share.

Mark Haefele, chief investment officer at UBS Global Wealth Management, said in a client note Monday that while the consensus 2023 bottom-up EPS estimate for the S&P 500 has fallen slightly lower to around $226 in recent weeks, his the team still expects it to pull back further to around $215.

For context, the EPS figure is pegged at $217.69 in 2022 and $137.77 in 2020, but only $99.19 in 2011 after the 2007-2008 global financial crisis, according to FactSet data.

While Principal’s team does not expect a repeat of the “45% or even 50% dot-com crash” that followed the 2008 crash, they cautioned that they see a need for the Fed to “prioritize this time around inflation”, as it is unlikely to deliver “any monetary relief even as earnings forecasts are sharply reduced”, leading them to their warning of a 1980s-style 30% decline.

Major Asset Management oversaw approximately $507 billion in assets under management, as of June 2022.

Stocks rallied on Monday, with the S&P 500 up 1.6% in afternoon trade and above the 4,000 mark, while the Dow Jones Industrial Average DJIA,
rose by about 370 points, or 1.1%, and the Nasdaq Composite Index COMP,
it was 2.3% higher, according to FactSet.

to read: S&P 500 earnings softening backdrop challenges stocks in the “very near term,” RBC says

While fourth-quarter corporate earnings have been mixed so far, another deluge of results from Johnson & Johnson JNJ,
Microsoft Corp MSFT,
Tesla Inc. TSLA,
Verizon Communications Inc. VZ,
International Business Machines Corp. IBM,
and Intel Corp. INTC,
due in the next few days.

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