In life as in markets, there will always be macro folks and micro folks, each tending to believe that their approach is better than the other. The internet is filled with zippy quotations exhorting investors not to lose “sight of the big picture” while also remembering that “God is in the details.” A few others encourage them to balance the two, but those are rarer and harder to convey on a bumper sticker.
By some measures, the US stock market’s “big picture” and “small detail” people — the Wall Street strategists and analysts — haven’t been this divided on the outlook since the financial crisis. Strategists, who use “top-down” frameworks to divine the most likely path of the S&P 500 Index, generally believe the market has blown past its 2023 potential and will end up backpedaling further. Analysts, the bottom-uppers who aspire to know the ins and outs of individual companies, think the index has room to run.
History isn’t clear on whom to trust, so I’ve attempted to unpack the sources of tension and seek some common ground.
Big Picture
First, consider the strategists. The average estimate from a Bloomberg survey of strategists from mid-June puts the S&P 500 at around 4,091 at the end of the year on $210 in earnings per share. They have lifted both the price and EPS targets from last month, but they still see a market decline of more than 6% between now and Dec. 31 — a rather gloomy outlook heading into what’s traditionally a profitable back half of the year. In the past 25 years, the index has risen 4.7% on average in the second half of the year, four times better than the first half. Of the entire quarter-century period, stocks fell in the second half in only eight years, and five of them were during the dot-com bust and financial crisis.
I suspect some of the skepticism is trickling down from sell-side economists, who foresee sequential contractions in real gross domestic product and rising unemployment in both the third and fourth quarters. Lately, economists have been revising up their forecasts for next quarter, but that shouldn’t necessarily be interpreted as a broad easing of concerns. The recession hasn’t been canceled (yet), although the worst of it has apparently been pushed back by another quarter.
The market isn’t the economy, but it’s not entirely disassociated from it, either. Strategists’ $210 full-year EPS call implies a continuation of the so-called earnings recession that would potentially last through the holiday shopping season. At that level, you’re not projecting a Wile E. Coyote moment as your base-case scenario, but you’re implicitly casting doubt on the prospects of the earnings rebound that the bottom-uppers are generally expecting to take hold relatively soon.
Also implicit in the price target is a trailing price-earnings multiple of about 19.5 — which suggests the current one of 20.8 is too high. (More on that later.)
World in a Grain of Sand1
Bottom-up analysts see the future differently. It’s worth remembering that consensus bottom-up estimates assume a 12-month time horizon, while strategist projections are for the 2023 calendar year and, therefore, expire in half that time. To make the estimates roughly comparable, I’ve made some adjustments detailed in the footnotes, which yield a 2023 year-end price target that’s somewhat lower than the actual target price — though still significantly higher than that of the strategists.2
Bottom-up EPS projections are a bit more optimistic than those of strategists as well at $218 a share for 2023, suggesting that profits will break out of the earnings recession by the fourth quarter. Putting the pieces together, the strategist consensus is that the S&P 500 will fall to 4,091 on EPS of $210 and an implied price-earnings ratio of 19.5, while bottom-up analysts suspect that the index will rise to 4,582 to 4,683 on EPS of $218, for an implied trailing multiple of 21 to 21.5 times earnings.
Synthesizing
As the exercise shows, the difference of opinion is largely a question of multiples much more than a disagreement over the path of earnings per share.
Strategists seem to think that the mix of recession fears and high-interest rates will keep trailing P/E multiples around the middle of their pre-pandemic distribution (the average was about 19.5 from 2015 to 2019), while bottom-uppers think that forward-looking markets will start looking ahead to a potential earnings rebound and lower interest rates in 2024 and 2025. As I alluded to above, history tells us little about which camp is “better,” though they each have their strengths.
In a sample dating back to 2005, strategists and analysts have both tended to overestimate returns at the start of the year, although bottom-uppers were slightly more prone to do so on the whole. With such a small sample, the difference isn’t statistically significant, however, and it disappears if you exclude the big overestimation whiffs of 2008 and 2022. As it turns out, both groups are awful at forecasting significant macro turning points such as the financial crisis, with strategists only slightly less so.
So who is right here?
One compromise is to take the average of the two consensus estimates. That yields an uninspiring price target of 4,394 — meaning the upside of the index currently sits at just more than 1%. With six-month Treasury bills paying about 2.5 times as much, you’re clearly better off in cash if you’re inclined to draw conclusions from this exercise.
Of course, if the market is on the cusp of a significant turning point — either blasting off after a subdued 2022 or crumbling under the weight of a looming recession — history shows that both sets of estimates are likely to prove drastically incorrect. The big picture folks and the small detail folks can quibble all they want, but both have proved powerless against serious market shocks. Unfortunately, “trust no one and defer to your own analysis” makes for a lousy bumper sticker.
1My apologies to the late William Blake for dragging him into this.
2One way to adjust the bottom-up price target for the shorter time horizon is to simply break the implied advance into two equal six-month periods. Bottom-uppers see a 12-month advance to 4,800, and 4,582 gets you about halfway there from current June levels. I also tried another method to account for seasonality, in which approximately three-fourths of returns are typically earned in the back half of the calendar year. Method No. 2 gets you a bit higher to 4,683.
A message from Advisor Perspectives and VettaFi: To learn more on this and other topics, check out our full schedule of upcoming CE-approved virtual events.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
