Yes, we think corporate earnings expectations are likely too high. This is because earnings are well above the long-term trend, and we expect inflation and higher policy rates will put downward pressure on profits margins.
After growing by more than 50% in 2021, global corporate earnings are significantly higher than the long-term trend. However, nominal global earnings are still expected to grow by 11% this year and approximately 8% in 2023 and 2024. On an inflation-adjusted basis, 12-month trailing earnings are approximately 15% above levels by the ten-year trend. On a forward basis, earnings expectations, in both nominal and real terms, are even further above trend. Historically, given cyclicality, earnings do not tend to persistently remain above trend.
Another factor putting earnings expectations at risk are higher financing costs. As central banks around the world raise rates to combat inflation, the yield on a broad global bond index has increased at its fastest rate in the last three decades. This has increased the cost of funding and will likely add pressure to global corporate margins and earnings, especially if companies lack pricing power. The rising US dollar is further exacerbating financing costs, especially since the war in Ukraine began. Many economies rely heavily on USD-denominated debt to raise funds. The stronger US dollar can make future fundraising more expensive and challenge some companies’ ability to service debt. Thus, on a net basis, the tightening US dollar will likely put pressure on corporate margins and earnings expectations.
Deteriorating corporate margins due to higher input costs pose another risk to earnings expectations. Global CPI expectations for 2022 have more than doubled from last year to 6.5%. Approximately 200 basis points of this increase came after the war in Ukraine began, underscoring the inflationary impact from this conflict. Not only are trailing 12-month margins well above ten-year averages, but earnings estimates still project higher margins from already stretched levels. For perspective, consider that global margins increased less than 1% in the five years ending in 2019, and yet 2024 margins are projected to increase by almost 4% over 2019 levels. We think it is reasonable to expect earnings estimates to adjust lower to reflect the pressure on margins from higher input costs.
The recent earnings period revealed that higher costs are also beginning to impact consumer behavior. As excess cash from stimulus packages dwindles, retailers —such as the US-based Target —shared that consumer shopping habits are shifting. Consumers, increasingly wary of rising food and fuel costs, are buying fewer big-ticket items and opting for lower-priced private brands. These shifts not only reduce corporate revenues, but also lower margins. While companies may be able to employ some offsets to cushion the impact of behavior changes, overall marginal changes in consumer baskets can indicate how households are reacting to economic changes.
Therefore, a combination of well-above-trend earnings estimates, risk to margins from higher financing and input costs, and changing consumer behavior gives us reason to think that earnings expectations are likely too lofty. But, within equities, we think earnings expectations are least at risk in value equities as they are less above trend relative to the broader market. Value equity valuations are also reasonable, and they tend to perform well during rising rate environments. Ultimately, if earnings expectations are revised downward, we think value equity performance will probably be more resilient than the market as a whole.