MarketScape: How to Reconcile Dueling Outlooks for U.S. Earnings
Amid dueling forecasts, we anticipate a slight adjustment in the U.S. equity margins. Gain clarity from Deputy CIO and CIO of Global Equities Michael Hunstad, Ph.D. as he discusses current conditions.
- The Promise of Artificial Intelligence
- The Gloomier Outlook for Earnings
- Our Outlook: Slight Decline in Profit Margins
With U.S. equity profit margins near historical peaks, there is a widely held view that contraction is inevitable. Over the past decades, long-term reductions in both interest and tax rates have buoyed margins to their current levels. But those trends are reversing. On the other hand, analyst consensus expectations point to significant margin expansion, driven primarily by anticipated gains from artificial intelligence. Both stories can’t be correct. We feel analyst expectations are too optimistic given current multiples and that rising interest rates will put downward pressure on margins, although not to the degree suggested by the current market narrative. Let’s take a closer look.
Despite a selloff in most major equity indices last week, forward price-to-earnings ratios remain elevated by historical standards. This suggests analysts believes earnings and margins are below normal and likely to increase. With an expectation of 8% revenue growth and 17% earnings growth, implied profit margins are anticipated to jump a full percentage point over the next year, a substantial increase off their already near-record levels. Much of this improvement is attributed to the expected efficiencies of artificial intelligence, but we feel those productivity gains are nebulous and hard to forecast, especially in the near term.
In stark contrast, market pundits are painting a rather gloomy picture on the direction of margins. Empirical evidence suggests the decline in interest rates and marginal tax rates have contributed materially to margin expansion over the last two decades. With the potential reversal of these trends combined with the challenges of shifting supply chains and overhead of the green transition, some suggest margins are likely to contract materially in the short term.
While we think there will be productivity gains to artificial intelligence, we believe the analyst outlook is overly optimistic as it will take time for these affects to take hold. In the near-term, we think the pressures of rising interest rates will outpace the efficiencies of artificial intelligence, but we do not expect a margin collapse. Any decrease will be modest and at least partially tempered by growth in the tech sector with its already outsized margin contribution We feel there will be modest, tenths of a digit, declines in margins over the near-term, but do not share the euphoria of analysts or the gloom-and-doom of a potential margin collapse.
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