RBC Says Hope Overwhelms Reality in Keeping Earnings Estimates

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(Bloomberg) — Stock analysts have been sticking to their earnings estimates despite a dramatic change in the economic outlook. They may soon have reason to get more pessimistic, according to executives at one of Canada’s largest investment managers.

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Most sell-side analysts are not pricing in the full impact that rising interest rates could have on corporate profits, said Stuart Kedwell of RBC Global Asset Management Inc. 

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“The yield curve is inverted and tightening has been loaded into the system, but we haven’t seen the effects of it,” Kedwell, the group’s co-head of North American equities, said in an interview at Bloomberg’s Toronto office. “All the leading indicators that often lead to earnings coming off are coming down, yet earnings estimates haven’t really reflected some of the concern that’s in the marketplace.”

Corporate management teams often use third-quarter earnings season as a chance to “reset the guidance” for the following year, said Irene Fernando, a senior portfolio manager at RBC. It’s only then that most equity analysts start changing their own estimates.

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That implies some stocks and sectors aren’t quite as cheap as they look, even after this year’s brutal selloff. RBC Global Asset Management’s official view is that inflation appears to have peaked. But the firm has shrunk its recommended allocation to stocks while boosting bonds in its latest quarterly outlook. 

Some macro analysts have started to ratchet down their expectations for the broader market. Goldman Sachs Group Inc. lowered its year-end target for the S&P 500 to 3,600 from 4,300 on Thursday, a day after Jerome Powell and the US Federal Reserve cut economic growth projections and signaled that rates could go higher than previously expected. The week prior, FedEx Corp. withdrew its fiscal 2023 earnings forecast because of deteriorating business conditions, causing its shares to plummet. 

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It’s the latest hit to already beleaguered equities markets. The S&P 500 Index has plummeted 23% this year, while the S&P/TSX Composite Index has fared slightly better with a 14% drop.

But despite these warnings, bottom-up earnings expectations have barely budged. After an event that jolts the markets, analysts typically take six to nine months to start revising their estimates, according to Fernando. Many company executives spoke about macroeconomic concerns in their second-quarter earnings calls, and negative revisions to earnings are coming next, she said. 

“If you listen to 2Q earnings, recession is on everybody’s mind. The word recession pops up on almost every other conference call,” Fernando said. “But the earnings themselves don’t reflect it. You could say that management teams are in a position where they are uncertain about the future.”