Profit warnings for the third quarter, which ends on September 30 for most companies, have started to worry Wall Street. So far most of the revisions have come from materials producers such as PP Industries (PPG) and Sherwin-Williams (SHW).
PP Industries, for example, lowered its sales number for the quarter by $250 million. That’s a decent-sized hit on Wall Street’s projected $4.3 billion in sales.
Sherwin-Williams said that limited availability of raw materials is hampering its ability to meet demand. Quarterly sales could fall by a low single digit percentage year over year.
But there are signs of a more extensive problem. Gina Martin Adams, chief equity strategist at Bloomberg Intelligence, reports that consensus profit margin estimates have fallen for 140 companies in the S&P 500 during the past three months. Bloomberg’s research also shows that a peak in margin forecasts has foreshadowed four of the S&P 500’s largest routs in the last decade, including the one last year.
Companies–and Wall Street analysts–are by and large saying that the problems are “transitory.” (A favorite word from the Federal Reserve to describe the current well-above target rate of inflation.) Supply-chain problems due to the Pandemic have made it tough for companies to meet demand. But, the consensus is, that sales will pop back up once the supply chain glitches are resolved. Of course, a lot of the pressure on margins is coming from that higher rate of inflation, and if higher inflation is not transitory, companies can expect to see margin pressure.
And, earnings warnings, even transitory ones, are a significant issue for a stock market is as highly valued as the current market and where earnings growth has been a key justification for higher prices.
No one knows if revenue growth might be slowing down because of the effects of the Delta variant–which would result in an earnings slowdown that is more than “transitory.”
The point for investors right now is that no one knows and that Wall Street is itself locked in a battle between analysts who see revenue and earnings growth slowing for more than just the next quarter and analysts and strategists who think that downward earnings revisions will be quickly reversed once companies start to report in October.
For the Standard & Poor’s 500 to trade at something like its five-year average of 19.6 times earnings per share for the stocks in the index, earnings would have to climb to $228 a share for 2021.
But in the last few weeks analysts have cut their earnings estimates for the index to $200 a share for 2021.
Which would mean that stocks would have to trade at well-above their five-year average PE or that stocks would have to fall in price.
Compounding the argument and the uncertainty are projections that show the U.S. economy slowing in the second half of 2022 as almost all of the Pandemic stimulus expires.
It’s hard to justify a rising price-to-earnings ratio if revenue and earnings growth will slow in the second half of next year.
In the short-term, the uncertainty itself is likely to add volatility to the market and to keep pressure on stocks.
