What Do Gloomy Business Managers Know That We Don’t?

What Do Gloomy Business Managers Know That We Don’t?
Stéphane Renevier, CFA

almost 2 years ago1 min

Mentioned in story

All things considered, the S&P 500 has been holding up remarkably well, falling just 16% from its all-time high even as high inflation, extended valuations, and geopolitical risk have created a grim market environment. That’s largely because company profits have remained relatively robust, but diminishing corporate sentiment suggests that could be about to change.

After all, corporate sentiment has historically been an accurate short-term leading indicator of earnings-per-share (EPS) growth. When corporate sentiment (dark blue line in the chart above) has deteriorated, year-on-year profit growth (light blue line) has tended to fall sharply in the next quarter. That’s probably because a management team has a good idea of whether its company’s earnings will match investor expectations. So the more disappointing it suspects they’ll be, the more pessimistic it’s likely to feel.

Right now, corporate sentiment is at lows last seen during the onset of the pandemic, and it’s pointing to a 30-40% drop in EPS growth this quarter. That’s a far cry from the 5-10% analysts are expecting, mostly based on recent earnings updates (not always the most outside-the-box thinkers, analysts). And if profit growth does tail off as much as this indicator is suggesting, investors will have one fewer reason to buy into the stock market. Best case scenario, that’ll limit the potential for any rally in prices. Worst case, it could cause them to tumble…

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