Why stocks still could face a 1980s-style drop

A “meaningful fall” in corporate earnings that has yet to be accounted for in U.S. stocks could still trigger a sharp drawdown that rivals the 30% drop of the 1980s, warned Principal Asset Management in a new outlook.

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

“With wage growth so strong and consumer anxieties building, corporate profit margins are being squeezed from both sides,” the team said. “Earnings growth is under severe pressure.”

While the S&P 500 index
SPX,
+1.08%
lost almost 20% last year, its worst year since 2008, its earning-per-share metric has held up (see chart) better than in past drawdowns of at least 10% since the 1960s.

S&P 500 earnings per share drawdown isn’t yet happening


Bloomberg, Principal Asset Management

EPS refers to net income divided by the number of shares outstanding, giving an indication of how much money a company makes for each share of stock.

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

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

While Principal’s team doesn’t expect to see a repeat of the “45% dot-com bust or even 50%” drop that followed the 2008 crash, they warned see the Fed’s need to “prioritize its inflation fight this time,” as making it unlikely to will deliver “any monetary relief even as earnings forecasts are cut sharply,” which gets them to their warning of a 1980s-style 30% decline.

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

Stocks punched higher 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,
+0.66%
was up about 370 points, or 1.1%, and the Nasdaq Composite Index
COMP,
+1.81%
was 2.3% higher, according to FactSet.

Read: S&P 500’s softening earnings backdrop is a challenge for stocks in ‘very near-term,’ says RBC

While corporate earnings for the fourth quarter have been mixed, so far, another deluge of results from Johnson & Johnson
JNJ,
-0.18%
 Microsoft Corp
MSFT,
+1.16%,
 Tesla Inc.
TSLA,
+7.70%
 Verizon Communications Inc.
VZ,
-0.54%,
 International Business Machines Corp.
IBM,
+0.59%
 and Intel Corp.
INTC,
+3.30%
are due over the next few days.

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