During earnings downturns, despite the potential for further earnings weakness, markets have historically responded with expanding multiples ahead of an earnings trough. While 2023 presents unique challenges, a resilient economy characterized by easing inflation, reduced supply chain pressures, and proactive cost containment efforts suggest opportunities for potential outperformance exist within companies focused on improved operating efficiency and margin stability.

Stock market and earnings
S&P 500 Index price and trailing earnings-per-share since 1990

Chart of stock market earnings using S&P 500 Index price and trailing earnings-per-share from 1990-Feb. 2023

Clearnomics, Refinitiv, Standard & Poor’s, Principal Asset Management. Data as of February 15, 2023.

As anticipated, year-over-year earnings growth for stocks in the S&P 500 has flatlined and dipped into negative territory based on 4Q 2022 earnings reports.1 Interestingly however, equity returns during this reporting season have been generally vibrant. Even when companies reported less than stellar earnings, they have still been well received if their managements communicated a focus on operational efficiencies and protecting future margins.

During earnings downturns, despite the potential for further earnings weakness, markets have historically responded with expanding multiples ahead of an earnings trough (2009, 2016). The unique risk facing investors in 2023, however, is the possibility of an earnings recession coupled with a Federal Reserve that is fixated on its inflation fight—and not in a position to cut rates in support of both economic and corporate growth, as it had in previous cycles.

Despite the concern, the economy is showing resilience—the labor market is robust, consumers are spending, supply chain pressures have reduced, and companies are implementing proactive cost containment efforts—all of which are bullish for corporate profitability. While this likely impedes the Fed's goals of arresting inflation (and provokes higher rates for longer), the potential for margin preservation supports a more bullish case for investors. Within portfolios, international equities and higher quality small- caps that are anchored by sustainable earnings are poised to benefit and may present an opportunity for potential equity market outperformance.

1 As of February 16, with approximately 70% of companies having reported earnings for 4Q 2022, year-over-year earnings growth is currently estimated at - 3%.

Macro views

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