Too calm, too quickly? Too calm, too quickly? Too calm, too quickly?

Investors should not wish for an average equity market

Peter Garnry

Head of Equity Strategy

Summary:  Net profit margins are still fat in the S&P 500 sitting well above the historical average and revenue growth has recently also been strong. But what if the recent trajectory of margin compression continue pushing it closer to the historical average in the S&P 500 and revenue growth also comes down with the slowdown in nominal GDP? These are some of the scenarios we look at in today's equity update in order to calculate the sensitivity to the ongoing margin compression which undoubtedly is the most important risk factor for equities next year.

The margin compression dynamics are key next year for S&P 500

As Disney showed in their earnings release margins everywhere are coming down from their high pink skies as we have highlighted in our recent equity notes Earnings season fades with cyber security stocks in big plunge and Consumer industries are seeing growth and margin expansion in Q3. The margin compression dynamics have got little attention so far with the 20% decline in S&P 500 since the peak being mostly attributable to higher interest rates causing equity valuations to come down. But as we have highlighted in several of equity notes, net profit margins soared to all-time highs during the pandemic and the past five years have seen profit margins globally running well above their historical average. Inflation, higher interest rates and wage pressures will continue to impact margins negatively in 2023. How will it impact the S&P 500?

S&P 500 cash index | Source: Bloomberg

The current 12-month trailing net profit margin in the S&P 500 Index is 12.4% down only 0.1%-point from its peak a couple of quarters ago. Trailing figures are slow to capture quick changes and the Q3 net profit margin has declined to 11.8% from 12.7% in Q2, a big drop in a single quarter. The 12-month trailing revenue growth is 14% compared to a year ago. If we assume that the net profit margin will decline to the historical average since 2002 at 9.3% and revenue growth slows to around 7-9% consistent with the lag from nominal GDP growth then the S&P 500 could see a price range indicated by the green rectangle. This assumes no change in the P/E ratio. The average of those values in the green rectangle is 3,223, which not far from our target on the S&P 500 of 3,200 and would constitute to 16% decline from the current level. If the S&P 500 sees net profit margin going to the historical average of 9.3% and revenue growth also hitting the historical average of 5% then the valuation is 2,969 assuming no change to the P/E ratio.

If we assume lower margins also coincide with a slowdown in the economy the equity risk premium might increase, that is at least historically been the case, which in turn would lower the P/E ratio unless interest rates decline a lot next year. The current difference between the US 10-year yield and the earnings yield on S&P 500 is 1.3%-point which is half of the historical average since 2002. If we assume a decline in the net profit margin to 9-10% next year, revenue growth of 7-9%, and an earnings yield premium over US government bonds back to the average at 2.6%-point the we get a different valuation area as observed in the green rectangle. The average price here is 2,615 around 32% lower from the current level.

If assume the most extreme scenario over the next 4-5 quarters of the equity market going back to the long-term average on all variables then the valuation is 2,409. This figure is so shocking that nobody would wish an average equity market but instead a more inflated one while we ride out the inflation wave. What is our base case scenario based on the current trajectory, assuming no severe recession but a shallow one with nominal GDP pacing on? That would be the net profit margin down to 10% (so still above the average) and revenue growth around 8-9% with the P/E ratio falling from 18.5x today to around 17x which translates into around 3,130 on the S&P 500 which is a bit below our 3,200 level that we have put out as our target for when the market bottoms. But with everything else in life the circumstances change all the time and many things could move our prediction such as the war in Ukraine, China’s degree of success with its less strict Covid restrictions, inflation and wage dynamics, and finally the energy market.

How to set up the portfolio against the margin compression

The past year the margin pressure has been the biggest industries such as media & entertainment, financials, banks, semiconductors, utilities, real estate, and health care equipment. On the flipside industries such as energy, insurance, transportation, retailing, software, and pharmaceuticals have preserved or even expanded their margins. Based on the expected margin compression dynamics in 2023 we recommend investors balance their portfolios away from the hardest hit industries as things could get even worse. This idea overlaps with our thesis the physical vs digital world. Another way to reduce risk during margin compression is to hedge the portfolio using instruments that rise in value when the S&P 500 or another equity index falls in value.

On a single stock basis the list below highlights the biggest companies in each of the categories mentioned as those that have preserved or expanded their operating margins. The list is for inspiration and should not be viewed as investment recommendations.

  • Exxon Mobil
  • Chevron
  • Shell
  • Allianz
  • Chubb
  • UPS
  • Union Pacific
  • Microsoft
  • Visa
  • Oracle
  • Johnson & Johnson
  • Eli Lilly
  • Roche


The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (
Full disclaimer (

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region


Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.