Earnings Forecasts Too Rosy | Seeking Alpha

“Some investors think earnings expectations are still too rosy,” according to Karen Langley in the Wall Street Journal.

Ms. Langley adds that S&P 500 profits for the next year show a 7.8 percent growth.

Last week, the S&P 500 Stock Index traded at 15.9 times its projected earnings over the next twelve months. This is pretty much in line with the 20-year average of 15.7.

But, if the earnings growth does not pan out, well, stock prices, right now, are too high.

However, this is not really what the investment community is focused on.

Investors are really focused on what the Federal Reserve is doing…or what the Fed is going to do.

And, the focus has been so intense, it is hard to believe that investors are really building in good company performance into the stock prices.

So, even though many companies may be doing a very good job managing their performance, it is not altogether clear that they will be given “good marks” for achieving a good outcome.

And, hanging over this environment is the cloud of radical uncertainty.

Investors…and other analysts…just don’t know what outcomes might be going forward.

The Fed Wants The Stock Market To Decline

The scary thing is that the Federal Reserve really doesn’t want the stock market to rise.

The Fed wants to see the stock market fall.

The S&P 500 has already fallen by 24 percent in 2022.

The Federal Reserve wants the stock market to decline, even though corporate earnings perform well.

The reason?

Well, the Federal Reserve is fighting inflation.

The Federal Reserve has recently begun a program of “quantitative tightening.”

The Federal Reserve plans to reduce the size of its securities portfolio by $95.0 billion per month into 2024.

That is, unless the Fed “pivots” and backs off from its tightening.

But, right now, that is not the intent of the monetary authorities.

According to the “rules” of quantitative tightening, the Fed reduces the size of its portfolio by $95.0 billion a month for an extended period of time.

The Fed carries on this steady decrease in its securities portfolio in order to create a “wealth effect,” in this case a decline in stock prices, that will cause consumers and others to reduce their spending and this will take pressure off of markets so that prices can moderate and inflation can return to the Fed’s 2.0 percent inflation target.

In today’s environment, corporate earnings may remain strong for a while longer.

This would mean that then the price-earnings ratio that now exists, 15.9, would have to drop.

So, if the stock market declines in price, as the Federal Reserve seems to want, the Fed would have to influence investor confidence through the financial actions it is carrying out.

This is where the uncertainty really comes into play.

If corporate earnings remain high for a while longer, the downturn in the stock market would all come about by the Fed’s financial manipulation.

The point is, the Federal Reserve wants to see stock prices decline, and the leaders of the Fed believe that they have the program in place, the program of quantitative tightening, that will achieve its goal.

Earnings Reports

So, the question becomes, will an economic recession hit the U.S. economy, and will profits drop, falling in line with the economic downturn?

The earnings will start to come in this week.

What will they look like?

If corporate earnings come in quite strong, will this provide investors with the encouragement to keep stock prices from falling further or to even help them move up?

If earnings come in at decent levels and stock prices steady or rebound, the Fed will still keep on with the monthly reduction of its securities portfolio.

This is exactly the way the Fed responded as it was conducting its two rounds of quantitative easing following the Great Recession, and following the market turmoil following the hit of the Covid-19 pandemic.

The thing that investors must accept in this age of “quantitative” programs of monetary policy is that the programs are designed to last for an extended period of time, even up to two years.

If corporate profits come in relatively strong this quarter, or they come in relatively strong over the next several quarters, the Fed will just continue on its path toward reducing the size of its securities portfolio.

Right now, the important thing for the Fed is to get stock prices moving downwards and to keep them falling.

Will the Federal Reserve “back off” if the market collapses?

I believe that they will…but…

The program of quantitative tightening that the Fed has now implemented, I believe, was constructed so that the monthly reduction in the securities portfolio is small enough so that it can keep going for quite a while without causing a market collapse.

The Fed wants this effort to continue for some time.

The Fed wants to get the inflation rate back down to 2.0 percent. Given the way it is approaching the problem, I believe that the program was constructed in a way that policymakers are convinced that they will not have to “pivot” from the effort.

So, the Fed would still like corporations to produce strong profit results.

Whether or not they do will depend upon how “weak” the economy becomes because of the Fed’s efforts to raise interest rates.

Investors must keep on top of this information, not only for deciding whether or not to invest, but, for deciding in which companies to invest during this time of radical uncertainty.