Wall Street analysts have a spotty history of calculating how geopolitical risks will weigh on the earnings and stock prices of the companies they cover. And that was before Russia invaded Ukraine.
With nearly a month still left in the first quarter, and the war in Ukraine creating numerous possibilities for disruptions -- from mundane supply issues to catastrophic bloodshed -- can stock market prognosticators really tell investors what lies ahead? Or is everyone in the dark at this point?
“There’s a little bit of that flying blind feeling,” said Dan Eye, chief investment officer at Fort Pitt Capital Group in Pittsburgh, whose firm buys sell-side research but doesn’t depend on it for long-term investment decisions. “Some of the sell-side information can be irrelevant given how quickly the geopolitical situation is changing.”
All of this uncertainty has many analysts on edge about their earnings forecasts. So far, there hasn’t been a catalyst big enough to push expectations lower for the year. But a surge in fuel costs could do it, specifically if U.S. oil prices surge 100% from a year ago and gasoline prices subsequently hit $5 a gallon, according to Nicholas Colas, co-founder of DataTrek Research.
“Gas prices at $5 a gallon is a real shock,” Colas said. “That’s the kind of thing typically causes a recession.”
The national average gas price hit $3.84 a gallon on Friday, up 40% from a year ago, according to AAA. And a barrel of West Texas Intermediate crude costs roughly 75% more than it did a year ago.
But before analysts start cutting their estimates, Colas expects that in the coming weeks companies will begin to warn that their projections for the first quarter are lower due to a slowdown in economic growth.
In some ways that’s already starting to happen. The number of companies that have revised their first-quarter guidance downward is 3.6 times the number that have revised it higher. That’s the highest “negative-to-positive guidance ratio” since the first quarter of 2016, when markets were mired in a global manufacturing recession, according to recent note by Morgan Stanley strategists led by Michael Wilson.
Earnings revision breadth -- the difference between upgrades and downgrades in sell-side earnings estimates over the total number of estimate changes -- is falling fast and close to turning negative, they wrote. Meanwhile, valuations remain high by historical standards despite this year’s 8% drop in the S&P 500.
In the past four weeks, roughly 60% of the earnings-per-share revisions for S&P 500 companies have been downward, the most since May 2020 when businesses were still adjusting to the pandemic, according to data compiled by Bloomberg.
Among those with downward revisions include reopening trades from casinos to cruise lines to travel companies like Caesars Entertainment Inc., Royal Caribbean Cruises Ltd. and Booking Holdings Inc. The S&P 500 Energy Sector is well represented among those with upward revisions, including Exxon Mobil Corp., ConocoPhillips and Marathon Oil Corp.
Of course, skepticism about sell-side research isn’t new. Investment managers aren’t shy about complaining that they’re being sold something.
“I certainly don’t rely on sell-side research,” Patrick Fruzzetti, portfolio manager at Rose Advisors in New York, said in a phone interview. “I read it, but I don’t depend on it.”
But these challenges are different because the impact of geopolitics on stock prices and corporate bottom lines is so difficult to calculate. The S&P 500 Index briefly fell into a correction last week for the first time since 2020’s pandemic-fueled swoon, inflation is the highest inflation in a generation and the Federal Reserve plans to raise interest rates as soon as this month.
Now there’s a war.
“It’s what we don’t know that can hurt us the most, which means it’s not a time to be overconfident about the future,” the Morgan Stanley strategists wrote. “Earnings growth assumptions are starting to look too high.”
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