Earnings outlook 2023 and the evolving Tesla risk

Peter Garnry

Chief Investment Strategist

Summary:  Consensus is growing for flat earnings next year but that would suggest the net profit margin staying close to the all-time high and not seeing much pressure. This stands in stark contrast to the wording from CEOs in Q3 earnings releases singling out wage pressures and margin pressure as the biggest threat to earnings. The Q3 earnings figures suggest the margin compression is accelerating and changes in the operating margin is directly associated with the change in earnings over one year. Our base case scenario is negative earnings growth next year and another troublesome year for equity investors.


Flat earnings growth in 2023 is a fantasy

In several equity notes we have highlighted that the 12-month forward earnings estimate on S&P 500 is too high currently at $235.34 which is 7% above the expected FY2022 EPS of $219.38. There is nothing unusual in this divergence conflicting with reality as sell-side analysts have a natural long bias, which is well described in research papers, and are slow to react and incorporate new information. The fact that the 12-month forward EPS estimate on S&P 500 is only 4% from its recent peak despite the ongoing margin compression says it all. In any case, many sell-side banks are these days publishing their S&P 500 EPS targets for 2023 and there seems to be a growing consensus that we could flat earnings. In our view this is very naïve. Let us explain why.

If you take EPS of $220 next year and divide with the expected revenue per share of around $1,800 which fits pretty well with a 1-year lag in US nominal GDP growth, then you get a net profit margin of 12.2% which exactly where the 12-month trailing net profit margin stood at in September (see chart). In other words, this view implies that S&P 500 companies can maintain their net profit margin next year. Before go into the arguments why this is a completely detached assumption it is important to understand why our obsession about operating and net profit margins are so important.

If you look at our scatter plot with the 1-year change in operating margin on the x-axis and 1-year change in EPS on the y-axis for the MSCI World we observe a clear association between these two variables. In other words, when looking over a short time period such as one year, the changes in earnings are strongly associated with changes in the operating margin. The variance around the linear fit is a function of revenue growth, interest rates, and the effective tax rate. Okay so talking about earnings in 2023 is essentially a talk about whether operating margins can expand, stay flat, or decline. Our view is that the operating margin will decline next year. Here is why.

  • Companies are constantly talking about margin pressures in their Q3 earnings related to especially wage pressures and to some extent still commodities and energy costs. The fact that the Q3 net profit margin in S&P 500 is 11.9% (below the 12-month trailing figure) and trending lower suggests that margins are coming down faster than expected.

  • The operating and net profit margin are both coming off historically high levels and margins are a mean reverting process, so this alone indicates that margins will trend down from current levels.

  • Wage growth in the US and Europe is the highest in many decades and the main concern of CEOs as wage compensation is typically the biggest cost item for many companies. Whenever you observe outlier data points an investor and analyst should apply the precautionary principle and high wage growth is difficult to offset in an inflationary environment when recent price hikes by companies have now reached a point where they are destructive for volume growth (Home Depot being a recent example of this).

  • Another downside risk to EPS next year is that revenue growth could be lower than current estimates as nominal GDP growth is coming down to 6.7% annualised in Q3 down from the average 12.2% annualised in 2021.

On top of this, higher interest rates will increase drive financing costs higher. Not by much because only 20% of the outstanding debt is getting refinanced over the next 12 months, but it will still subtract from operating income before we reach EPS impacting the net profit margin. If we are right about our operating margin call for 2023 then the impact on S&P 500 will vary depending on the equity risk premium (P/E ratio), revenue growth and the actual net profit margin. In our recent equity note Investors should not wish for an average equity market we go through the sensitivity on the S&P 500 related to these variables.

Tesla concentration could spark a domino effect on US equities

Back in early 2021 we wrote several equity notes (here and here) describing the big overlap in positions among investors holding Tesla share, cryptocurrencies, and the Ark Innovation ETF. Another common red thread in this ‘risk cluster’ is that the common investor in these instruments is young men with ultra-high risk tolerance. Since early 2021 the sequence has been that first Ark Innovation ETF topped out, then cryptocurrencies and Tesla topped out in late 2021. This year cryptocurrencies have collapsed and with the recent bankruptcy and fraud at the crypto exchange FTX amplifying the risk and downside moves in cryptocurrencies. Tesla has hold the line as the social phenomenon Elon Musk has kept the narrative around Tesla’s growth intact.

However, a recent mass recall of cars in the US and China’s difficulties to kickstart the economy have left investors worrying about the growth outlook. Supply constraints on batteries and generally high commodity prices, soaring energy costs, and chip shortages have constrained production for Tesla. To top it all up, Elon Musk’s acquisition of Twitter has pulled him into the vortex of saving the company as his decisions have scared advertising turning Twitter from a cash flow positive business to a cash burning platform with an increasing existential risk for the social media company. Investors are also beginning to worry that Musk’s behaviour on Twitter and priorities are clouding his focus and maybe even tarnishing his brand, which ultimately could spill over into the Tesla brand. Tesla shares were down 7% in yesterday’s trading and thus is a clear source of risk coming into the market with Tesla being a big position in many retail investors’ trading account.

Tesla share price | Source: Saxo

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.