STLA - S&P Earnings Estimates For 2024 Are Much Too High

2023-09-18 09:38:32 ET

Summary

• The current consensus is that S&P 500 earnings will increase 12.2% on a year-over-year basis in 2024 while revenues rise 5.6%.
• However, the economy's key growth drivers, such as housing, the consumer and industrial production, are facing challenges and not looking promising.
• Most importantly, consumers are facing challenges with falling inflation-adjusted income, depleted savings, and increasing debt, making it unlikely for the S&P 500 to meet earnings growth projections.
• We dive into the crumbling growth drivers of the economy and why profit projections for 2024 currently seem ludicrous in the paragraphs below.

Ludicrous - so foolish, unreasonable, or out of place as to be amusing; ridiculous

There is no shortage of Ludicrous Things to write about when it comes to the economy and the markets right now. However, one item that should be on that list but rarely gets discussed is forward earnings estimates for the S&P 500. As of last week, FactSet had the current analyst firm consensus projecting year-over-year earnings growth of 12.2% and revenue growth of 5.6% for the S&P 500 in FY2024.

To me, that is like the MGM Grand Sports Book putting an over/under score of 60 on this week's Browns/Steelers game. A prudent better is going to take the under every time. S&P earnings came in at roughly $197 for 2022. They are currently projected to come in at $220 for 2023. This was a much better performance that was estimated at the start of 2023, it should be noted.

Earnings for 2023 have been aided by faster than expected GDP growth in the first half of 2023 (just over two percent). However, government spending has been a big part of that growth. The national deficit for FY2023 is likely to come in at just under $2 trillion, in a non-recession year! To put in perspective, the entire national debt was $1.4 trillion when Reagan left office.

U.S. GDP this year should come in around $26 trillion, which means the federal government will have run a deficit of over 6.5% of GDP this year, and the economy is still plodding along at two percent growth rate. Obviously, this type of governmental largess is not sustainable with the national debt already at some $32 trillion.

The economy's other key growth drivers are also not looking good at the moment. Housing, which historically contributes 15% to 18% to national GDP is suffering from over seven percent average 30-Year mortgage rates. This is the highest mortgage level since early this century.

Largely as a consequence, Housing Affordability is now at historical lows. Housing prices have held up well given the average mortgage rate has more than doubled since the start of 2022. However, a large part of this is due to the lack of housing inventory. Individuals simply don't want to sell their homes with the ultra-low mortgage rates, even if would mean substantial capital gains.

Home builder stocks have held up extremely well this year given these headwinds as the SPDR® S&P Homebuilders ETF ( XHB ) has gained nearly 30% so far in 2023. However, this ETF seems to be in a topping out phase since mid-summer and I have recently opened a small bear put spread against home builders using this ETF.

Home cancellations also just hit a 10-month high, and I also have some bear put spreads against LGI Homes ( LGIH ) , whose stock is down just over 10% since I slapped a Sell on the shares on July 10th. Lower housing activity will obviously impact ancillary industries and is the key reason home furnishing sales were down 7.8% on a year-to-year basis in the August retail sales report .

Industrial production contributes approximately 11% to national GDP. The monthly PMI reading has printed recessionary level figures below 50 for 10 straight months now. This part of the economy is also not going to benefit from the strike the UAW just called against Ford ( F ) , General Motors ( GM ) and Stellantis N.V. ( STLA ) and that has the potential to last weeks if not months. The strike is likely to tip the state economy of Michigan into recession if it has any duration.

One of the few beneficiaries of this strike action is going to be Tesla Motors ( TSLA ) , which has a non-unionized workforce and already has a massive lead in the electric vehicle industry. Ford could particularly be hurt given it already expected a $4.5 billion loss from its EV operations in FY2023 prior to this strike. This is one key reason I called Ford stock a potential ' Value Trap ' five weeks ago. The company just announced it was laying off 600 workers because of the strike action.

Finally, we get to the 800lb gorilla in the room. The Consumer, who accounts for just over two thirds of economic activity. Consumers are facing substantial challenges on multiple fronts. Average inflation adjusted income has fallen for three straight years now, including by 2.3% in 2022 alone. Up to this point, consumer spending has been maintained by the massive excess saving generated during the Covid pandemic via various government programs.

Unfortunately, those savings are now spent, and personal savings fell nearly $150 billion in July to just over $700 billion. The personal savings rate is now just 3.5%, the lowest levels since the Great Financial Recession. According to a recent survey , 61% of Americans are living paycheck to paycheck. Increasing they have turned to debt to make ends meet, which is one reasons both credit card debt ($1.03 Trillion) and auto loan obligations ($1.6 trillion) are at all-time highs.

It would be hard enough for S&P 500 to hit earnings growth projections in the low teens for 2024 if the economy was delivering 2% to 3% GDP growth on a consistent basis. However, to believe this will happen with so many key economic drivers under mounting pressure is close to ludicrous.

My view is investors will be lucky to get half that growth in 2024, and this is if the country manages to skirt a recession. However, as I detailed in my recent article ' Shades of 2007 ' a recession appears to be more and more likely in the quarters ahead. If we do get an economic contraction, earnings growth will likely turn negative in 2024.

To me, it is clear that the current market is valued largely on these robust earnings projections for 2024. Unfortunately, these estimates are likely not to come to fruition. When earnings projections are taken down in the months and quarters ahead, that should make equities vulnerable to a pullback. Perhaps, a significant one. Investors should position themselves accordingly.

I'm not upset that you lied to me, I'm upset that from now on I can't believe you . ? Friedrich Nietzsche

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