U.S. stocks are up sharply this year driven by robust earnings expectations; yet, those views may prove overly optimistic, cautions National Bank Financial Inc. (NBF) in a new report.
According to the report, the S&P 500 is up 17.7% so far this year, well ahead of its historical average of about 7%.
“The frenzy on U.S. stock markets is being fuelled by ambitious earnings expectations, with the consensus forecasting a 13% increase in S&P 500 earnings per share over the next 12 months,” it said.
However, markets may be poised for disappointment, NBF suggested.
“As the economy surprises to the downside and the Fed moves closer to cutting interest rates, we believe equity investors are overly optimistic about the ability of central banks to quickly reignite economic acceleration and stabilize the labour market,” it said.
The report said the Bloomberg Economic Surprise Index, which tracks the difference between actual economic data and median forecasts, is currently negative. Historically, negative readings on that index have preceded downward earnings revisions.
“Earnings forecasts have been revised downwards by an average of 7.2% in the three months following a reading of less than –0.5 on the Bloomberg Economic Surprise Index, which is currently the case,” it said.
As a result, NBF said it sees “a significant downside to the consensus estimates for [earnings per share] growth in the coming months.”
The sectors most prone to downward revisions include the energy, materials and financials sectors, it noted.
NBF is also skeptical about the outlook for Canadian equities.
“Earnings expectations are almost as ambitious as in the U.S., with [earnings per share] growth of 11% expected next year despite the economy continuing to slow,” it said.
Most of this growth is expected to come from margin expansion, it said, given that headline sales growth is forecast at 2.2%.
“To meet the earnings growth target, profit margins would therefore have to rise to a record high,” the report said. “That is a very tall order indeed given that pricing power is limited in a lower inflation environment.”
Against this backdrop, NBF said it’s currently underweighting equities and overweighting bonds and cash.