Stocks Are Courting a Nasty Surprise on Earnings

Wall Street analysts have trimmed their overly optimistic earnings estimates slightly in recent months, but they’re still nowhere close to acknowledging the threat of a recession. That leaves the market especially vulnerable if other companies follow FedEx Corp.’s move to withdraw its profit guidance by lowering their own outlooks.

FedEx’s decision late Thursday sent its shares tumbling the most since 1980 and came amid a growing disconnect between the macroeconomic outlook and analysts’ earnings projections, which are driven to a large degree by the hints that companies provide about their futures.

The median economist surveyed by Bloomberg now gives even odds of the US experiencing a recession in the next 12 months, up from about a 33% probability at mid-year. Economists are concerned that the Federal Reserve’s efforts to rein in the worst bout of inflation in 40 years will ultimately come at the expense of the job market and resilient consumption trends. The hard data suggest that the economy hasn’t buckled yet, but history suggests that it will eventually, and there’s little chance that stocks would be immune.

Since 1960, the average peak-to-trough earnings drop in a recession is about 31%, based on Yale University professor Robert Shiller’s data. Yet sell-side equity analysts aren’t even close to incorporating such a drop. In fact, estimates for both 2022 and 2023 still imply that rolling 12-month earnings will maintain their steady upward slope, implying something close to a best-case scenario.