Blog | CB Investment Management

Crisis In Fed Governance And Wall Street Guidance

Central Banks and Wall street remain cycle blind. A major problem but also an opportunity.

Why Wall Street earnings estimates are likely to be wrong at the worst time to be wrong.

So let’s get real here, Jay. You need to stop with towing the line of incompetent forecasters and get with the real world economics and markets program. If you don’t, selfishly, I am just going to keep making more and more money on the short side.
Keith McCullough

Despite economic growth already showing signs of weakness, inflation running at the highest level in 40-years, and the Fed moving aggressively to tighten monetary policy, Wall Street analysts continue to suggest strong profit margins and rising earnings into 2023.
Lance Roberts

Investors are being told by the Fed Chairman that “There is no sign of a broader slowdown in the economy” and Wall Street earnings estimates project further gains in earnings deep into 2023 from already record levels.

In my October 19, 2021 Money Show video I projected a 95% probability that the US economy would be in a steep growth decline in Q2, 2022. Credit goes to Hedgeye.

How out of touch can the Fed and Wall Street be? There has now been a record first half drawdown in US equities and an already declining rate of change in reported earnings growth and economic growth too.

These weekly insights have consistently and proactively described over the last year, that slowing growth and the stock market drawdowns of 2022 were likely. This is timestamped and transparently available for review. It’s not complicated. Common sense and simple observation show that we have a crisis in central bank governance and Wall Street guidance.

Let’s Start With Wall Street

The chart below shows that earnings growth through 2021 was already through the upperbound of its trend line. Historically they have always peaked at these levels but Wall Street earnings estimates keep them accelerating into 2023!

The same information is shown in the chart below, as the deviation of earnings estimates relative to the long term growth trend. This shows that the last two times estimates deviated this much from trend there was a 50% drawdown in the S&P500, in 2000 and 2008. Wall Street earnings estimates seem to be saying “this time its different” once again.

The chart below shows the 30 year record of Wall Street’s forward earnings estimates relative to 12 month trailing earnings. There is no case, that I can see, where using the rate of change of 12 month trailing earnings, which is factual information, did not show more timely and valuable information than earnings estimates, which twice came down only at the worst time, which was at the end of a recession when markets had started recovering! Almost perfectly incorrect from a cycle perspective.

Furthermore, earnings estimates made this error the last two times that “this time it’s different”! Earnings estimates seem likely to get this wrong 3 times out of 3!

Wall Street Earnings Estimates Are Likely To Be Wrong At The Worst Time To Be Wrong

The chart above shows that already the more reliable 12 month trailing earnings turned down several months ago relative the earnings estimates. This indicator once again has exposed Wall Street estimates as cyclically incorrect.

The next few charts show the challenging conditions for the credibility of Wall Street’s earnings estimates.

The first chart below showing that consumer sentiment has made new lows and has a record divergence with all time high corporate profit margins.

No wonder consumer sentiment is so low. The chart below shows that both real income and the savings rate are as low as they have ever been.

Beyond that, households have just taken a big hit in their net worth. This will reduce growth further, and if this reverts to the 70 year average another sizeable hit has yet to come.

The performance of the the US dollar has a very tight correlation with corporate earnings. The recent rise in the US dollar suggest a significant earnings downgrade is due to corporate earnings, just from this source alone.

None of this has mentioned that Hedgeye’s historically accurate projections pointed to declining growth 6 months ago and project more weakness over the next 9 months in the US.

With the Fed tightening aggressively, and the economy clearly already slowing in the first half of 2022, it is simply a remarkable forecast to project ever rising earnings gains from already record levels into next year.

What will it take to bring down Wall Street earnings estimates? What will the market’s reaction be as estimates are forced to come down?

Investors need to carefully consider the credibility and track record of the sources of information and the guidance they are using.

Central Banks Are Finally Convinced Inflation Is The Problem

Now that commodities have broken their uptrend and inflation is most likely peaking, the BIS annual report came out this week with the headline: High inflation calls for timely and decisive central bank action: BIS.

According to the BIS’s Annual Economic Report 2022, the priority for central banks is to restore low and stable inflation. In doing so, they should seek to minimise the hit to economic activity, thereby safeguarding financial stability.

Regrettably, minimising the hit to economic activity requires early and timely action. Otherwise policy will be procyclically destabilizing, the exact opposite of the stated intention.

So, waiting for inflation to peak and the economy to slow means that it is already clear that they have failed to act in a timely fashion from the lowest real interest rates in four decades! It is hard to imagine worse execution of their stated objectives to “minimize the hit to economic activity.”

My Weekly Insights have already extensively discussed central bank performance, most recently in my June 17, 2022 Weekly Insight, Central Banks On Tilt, so there is no need to repeat our many other critiques.

So What’s An Investor To Do?

Clearly, a substantial missing piece in Wall Street and central bank thinking is awareness and execution in a cyclically efficient manner. For investors too this is where the greatest challenges lie, as navigating full cycle investing is essential and a distinctive differentiating factor for optimal long term performance.

Furthermore, any analysis involving Wall Street earnings estimates is not likely to be useful. The simple fact these earnings estimates are so inaccurate at key moments in time, raises many questions about all research from Wall Street and explains the problems so many investors have as a result.

I have not subscribed to any Wall Street research for the last 22 years! The best research comes from independent sources, where their is a clear pattern of a successful track record. Do your due diligence!

More generally, the key is to learn from successful investing – starting with the most successful investors of all time. Use Best Investor standards, and their principles, processes, and practices to transform your investment experience.

Some Useful Resources:

Four Steps to Becoming A Best Investor

Invest Like The Best: The Low-Risk Road to High Returns

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Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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