Earnings recession in 2023 is what matter the most
The Q3 earnings season is slowly coming to an end with the main conclusion being that companies are still overall doing well, but that margin compression is setting in with increasing force. Companies are highlighting wage pressures as their biggest concern and it is also the main dynamic that allow margin compression to continue into 2023 taking earnings down despite inflation lifting revenue growth. The chart below shows how wage growth in the US and Eurozone are trending higher to historical high level.
The story in 2022 has been the revaluation of equities due to the interest rate shock that followed the Fed pivot on whether inflation was temporary or not going with inflation being more structural and for longer than initially estimated. Falling equities have predominately been an interest rate dynamic and less so an earnings dynamic. The reason why equities have not fallen more relatively the big move in interest rates is the that the equity risk premium has not expanded dramatically. But that could quickly change in 2023.
S&P 500 earnings expectations for the next 12 months are coming down and are currently 4% lower than their recent highs suggesting that sell-side analysts are beginning to revise down earnings as a function of higher interest rates increasing financing costs and higher wage pressure compression the net profit margin. An earnings drawdown is typically associated with increased probability of a recession and that in itself drives the equity risk premium higher providing the ugly cocktail of both lower earnings and a lower multiple next year making 2023 another difficult year for equity investors.