Valuation ratios on U.S. stocks have gone south this year, resulting in a bear market since the S & P 500 peaked last January. Investors have been reluctant to pay ever higher prices for a dollar’s worth of uncertain future profits. But now, if the wheels come off second-quarter earnings that are about to be reported starting this week, another key support undergirding stock prices will be shoved aside, too. Leuthold Group director of research Scott Opsal recently wrote a report saying investors are always worried about earnings, but that there have only been four episodes of shrinking profits, as reflected in next 12-month earnings per share estimates since 1995. The worst one came in 2007, when EPS estimates plunged 39%. That was followed by 21% in 2020, 18% in 2000 and a “minor decline” of 5.5% in 2014. The problem now is that as recently as last month, analysts’ consensus estimates called for a 7.4% gain in earnings per share, to yet another record high, over the coming year. At the same time, rapid inflation, high energy prices and rising interest rates are threatening those profits. “If circumstances arise that squeeze corporate profit margins during a period of economic slowing, EPS will almost surely take a sizeable hit,” Opsal wrote. Stocks in 2000 and 2007 fell another 10% to 15% before bottoming out after EPS estimates peaked. After working sideways for a while, the market was still down by as much as 8% half a year after earnings estimates topped out. The best case for bulls today will come if the market today mimics the 2014 performance. “A minor dip in EPS estimates this year may be swiftly brushed aside if the overall macro story begins to improve,” Leuthold said.
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