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Pay No Attention as We Take a Knife to Profits, Strategists Say

Pay No Attention as We Take a Knife to Profits, Strategists Say

(Bloomberg) -- U.S. equity forecasters can’t get their story straight. In the last month, 10 of 24 strategists tracked by Bloomberg cut 2019 profit estimates for the S&P 500. But exactly none has lowered the price prediction.

For anyone who think equities dance to the tune of fundamentals, the willingness to slash one and not the other might sound strange. Ask the strategists and they say it all makes sense in a world where the only thing falling faster than earnings forecasts is bond yields.

“We acknowledge that we underestimated the potential trade war damage,” said Brian Belski, chief investment strategist at BMO Capital Markets who this week cut his S&P 500 profit prediction to $165 a share from $174. “Despite this revision, we see no reason to alter our year-end S&P 500 price target of 3,000 since our models and analysis still suggest that this level remains highly achievable.”

Pay No Attention as We Take a Knife to Profits, Strategists Say

In effect, the handicappers are saying valuations will expand to make up for the lowered earnings targets, counting on an improvement in investor psychology that is encouraged by Federal Reserve rate cuts. At 16.5 times forecast profits, the S&P 500 trades in line with the average multiple in the past five years. But relative to Treasuries where 10-year yields sit near a two-year low, stock valuations can be framed as cheap.

While strategists often revise their earnings estimates, that so many of them are cutting at the same time is unusual. The number of reductions is twice the rate from the last survey and tops the total seen during the first four months of 2019.

Their average profit estimate have fallen to $167.30 a share, down from $169.80 projected in early May. At the current price, the $2.50 reduction would end up having no impact on the S&P 500 should the price-earnings ratio rise by 25 basis points.

To be sure, investors have embraced risk after the Fed opened the door to rate cuts. After falling in May for the first time this year amid the trade skirmish, stocks have recovered more than half of the losses, with the S&P 500 rising in six of the last eight days and sitting less than 2% away from an all-time high reached in April.

“In contrast to the 2007-08 recession, there is an almost a paranoia amongst central bankers to avoid any potential financial hiccups that might hurt the real economy and cause a slowdown,” said Sean Darby, global equity strategist at Jefferies LLC. “The central bankers have become ‘trigger happy.’"

Darby slashed his full-year profit estimate by $15 to $158 a share while sticking to his price target of 2,900 for the S&P 500.

Pay No Attention as We Take a Knife to Profits, Strategists Say

One other reason that prognosticators have refrained from cutting their price forecasts is that they weren’t super bullish to begin with. Seven of them already expected the benchmark gauge to end the year lower than where it was at Thursday’s close. At an average 2,912, their forecasts pointed to a gain of less than 1% by December.

Mike Wilson, chief U.S. equity strategist at Morgan Stanley, kept his year-end forecast at 2,750, one of the lowest among peers, while trimming his profit estimates to $162 a share for both this year and next.

“With trade risks further adding to pressures on earnings growth, one piece of pushback we expect is why the multiples embedded in our target forecasts are not lower,” Wilson wrote in a note. “Forecasting the market’s multiple is obviously a difficult task but we think that as growth slows, falling yields and rising equity risk premium will offset to a degree.”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Brad Olesen at bolesen3@bloomberg.net, Chris Nagi, Jeremy Herron

©2019 Bloomberg L.P.