The performance of US stocks slowed further in the third quarter of 2022, basically approaching zero growth. In this article, we will focus on the analysis of the earnings prospects of US stocks under the increasing growth pressure and the impact on the follow-up trend of US stocks.

Growth trend: profits continue to slow, approaching zero growth; energy and transportation are the main contributions, while finance and technology are a big drag

U. S. stock earnings continued to weaken in the third quarter, approaching zero growth.

In comparable terms, the EPS of the S & P 500 grew just 0.6 per cent year-on-year in the third quarter (4.9 per cent non-financial), down from 2.9 per cent in the second quarter (10.5 per cent non-financial).

EPS in the third quarter of the Nasdaq 100 was-1% year-on-year, up from-5.1% in the second quarter. The S & P 500 exceeded expectations to 1.9% from 2.9% in the second quarter (the pre-epidemic average was 5.4%), and the higher-than-expected share also fell to 70% from 76% in the second quarter (the pre-epidemic average of 71%).

Overall, a further slowdown in US stock earnings is also expected under high costs and low demand.

Energy and transportation are the main contributions; financial pressure, pharmaceuticals, semiconductors and the Internet are also slowing.

Driven by a low base and a rebound in oil prices (oil prices averaged $98 per barrel vs in the third quarter. In the third quarter of last year, EPS in energy, consumer services and transportation grew by 152 per cent, 149 per cent and 68 per cent respectively compared with the same period last year, while cars and parts and real estate were also among the top growth rates (40 per cent and 39 per cent).

By contrast, financial pressure, third-quarter EPS year-on-year-19% (vs. Second quarter-26%). Loan losses of the big four banks (Bank of America Corporation, Citibank, JPMorgan Chase & Co and Wells Fargo & Co) rose to $4.6 billion in the third quarter, as a slowdown in loan demand combined with weakness in investment banking also weighed on profits.

In addition, the growth rate of raw materials, insurance, biopharmaceuticals, durable goods and clothing, semiconductors and media entertainment also declined significantly.

In terms of contribution, energy (4.1ppt), optional consumption (1.2ppt) and transportation (1.1ppt) are the main contributions, while communication services, diversified finance and insurance are obvious drag.

It is worth mentioning that the profits of technology companies, the leader of US stocks, have fallen and turned negative for five consecutive quarters, mainly due to the "triple pressure" of weak demand, a strong dollar and high inflation, and management said to control costs by slowing recruitment and layoffs.

Intel Corp, NVIDIA Corp and META technology leaders all missed expectations in the third quarter, with net profit falling 89%, 72% and 52% respectively compared with the same period last year. In addition, due to the high proportion of overseas income of technology leaders (53% vs on average FAAMNG. S & P 500 39%), the strong dollar also had a negative impact.

FAAMNG's non-financial share of net profit in the S & P 500 also fell from 27 per cent at the end of 2020 to 17.7 per cent in the third quarter. Many companies say they will slow down hiring or layoffs to control costs, and Intel Corp has proposed a $10 billion cost-cutting plan.

Demand and cost analysis: high costs continue to squeeze profit margins, and industries with low inventory have stronger bargaining power when demand falls.

Revenue continues to fall as demand cools, and high costs continue to squeeze profit margins.

Revenue of the s & p 500 rose 9.3% year-on-year (non-financial 9.6%) in the third quarter, down from 10.5% (non-financial 11.7%) in the second quarter. From a sub-sector point of view, compared with the second quarter, cars and parts rose significantly, but biopharmaceuticals and semiconductors fell significantly.

At the same time, high costs continued to squeeze net profit margins, with the s & p 500's third-quarter net profit margin of 11.3%, down from 11.7% in the second quarter, while non-financial net profit margins also fell to 11% in the third quarter from 11.3% in the second quarter. Excluding the energy sector, net profit margin fell back to 10.3 per cent in the third quarter (vs. 10.6% in the second quarter).

In terms of sub-sectors, the sectors of consumer services, household personal goods and public utilities have risen significantly, but software and services, raw materials, and media entertainment have dropped significantly.

Industries with low inventories can still rely on price increases to ease the pressure on the profit side.

For example, semiconductors have insufficient bargaining power due to high inventory and weaker demand, sales have declined significantly, and interest rates have also continued to be under pressure (third-quarter gross margin 49.9% vs. 51% in the second quarter, an average of 52.5% since 2013; net profit margin continued to fall to 21.7% from 22.3% in the second quarter.

In contrast, as inventories are still insufficient, companies can still maintain profits by raising prices (gross profit margin rose to 14.6% in the third quarter, an average of 12.3% since 2013; net profit margin rose to 5.9%, an average of 4.1% since 2013).

But we expect weaker overall demand to erode its profitability as real recessionary pressures magnify next year.

Quality of growth: slower bond issuance, lower cash flow and cash on hand; reduced buybacks; flat leverage but reduced solvency

In terms of growth quality, the non-financial ROE of the S & P 500 fell to 24.3% in the third quarter from 24.9% in the second quarter (dragged down by a decline in net profit margin), while non-financial non-energy ROE continued to decline (22.7% vs. 23% in the second quarter).

In the cash flow statement, the issuance of credit bonds slowed down in the third quarter, operating cash flow and cash on hand decreased, buybacks fell, and capital expenditure rose. From the perspective of leverage, financial leverage remained basically unchanged in the third quarter, but solvency declined. Specifically:

• Operating cash flow weakens, credit debt issuance slows down, and cash on hand decreases.

In the past 12 months, the non-financial non-energy operating cash flow of the S & P 500 continued to decline in the third quarter from a year earlier (3.8 per cent vs in the third quarter. 8.3% in the second quarter). Rising funding costs as a result of the Fed's continued tightening slowed corporate credit bond issuance further in the third quarter ($296.1 billion, down 33 per cent from a year earlier).

As a result, the amount of non-financial non-energy cash on hand fell from $1.51 trillion in the second quarter to $1.48 trillion in the third quarter, accounting for 3.8 per cent of total assets in the third quarter (vs. 3.9% in the second quarter).

From a sub-sector point of view, the proportion of cash in hand to total assets in optional consumption, communications services and information technology has dropped significantly.

• The scale of buybacks continued to fall.

S & P buybacks fell to $196 billion in the third quarter from $225.7 billion in the second quarter, or 2.8 per cent of market capitalization from 3 per cent in the second quarter. However, energy sector buybacks are still strong (from 6.1 per cent of market capitalization in the second quarter to 6.4 per cent in the third quarter), while information technology fell from 3.8 per cent in the second quarter to 3 per cent in the third quarter.

In terms of contribution to EPS, buybacks contributed 5.6% to recurrent EPS growth in the third quarter, up significantly from 3.3% in the second quarter, while Nasdaq buybacks contributed slightly more to recurrent EPS growth (2.4% vs in the third quarter. 2.2% in the second quarter).

• Leverage is flat, but solvency is lower.

In the third quarter, the overall non-financial net leverage ratio (net debt / net assets) of the S & P 500 remained basically unchanged at 77% of that in the second quarter, as did the median net leverage ratio of individual stocks (60% in the second quarter). However, the non-financial overall interest rate reserve ratio (EBIT/ (interest expense + capitalized interest) fell from 11.3 in the second quarter to 10.1 in the third quarter (the median interest reserve ratio for individual stocks fell from 9.6 in the second quarter to 8.9 in the third quarter).

In terms of sectors, the net leverage ratio of energy, health care and real estate fell in the third quarter, but information technology rose.

Inventory and investment cycle: enter the active de-treasury cycle; investment increases but it is difficult to hide the slowing pattern

Enterprises have entered the stage of taking the initiative to go to the warehouse, and the inventory of finished goods has dropped.

The United States has entered the stage of voluntary destocking. Total non-financial inventories of the S & P 500 continued to rise in the third quarter, but inventories of raw materials, especially finished goods, have gradually fallen, and inventory growth has peaked and declined year-on-year (17.5 per cent vs in the third quarter. 21.3% in the second quarter). The profit reduction during the active destocking phase (12-month dynamic EPS) averaged 7%, with the financial crisis in 2008 and the epidemic in 2020 having an even greater impact.

Capital expenditure is rising, but it may be hard to hide the overall slowdown.

Non-financial capital expenditure of the S & P 500 in the third quarter was 21% year-on-year, up from 17% in the second quarter; excluding energy, capital expenditure was 16.4% year-on-year (vs. 14.7% in the second quarter). The absolute scale is also rising, such as energy, telecommunications services, public utilities, science and technology hardware, semiconductors and so on.

From a macro point of view, non-residential fixed asset investment in the United States actually grew by 3.2% in the third quarter compared with the same period last year (vs. (2.4% in the second quarter), the scale was also higher than in the second quarter, with intangible assets and facility investment falling year-on-year, but equipment investment (third quarter compared with 5.3%vs. 2.0% in the second quarter), especially the marked rise in information processing equipment and transportation equipment, which may be related to the promotion of the Biden government's adoption of the inflation reduction Act and the Chip and Science Act in August 2022, respectively.

However, given the increasing downward pressure on US growth, corporate willingness to spend capital is also likely to be further curbed.

Scoring on demand, capacity utilization, inventory, capital expenditure, and leverage, we foundSemiconductorWeak demand, high inventory and investment, high leverage,Media entertainmentWeak demand, high inventory and investment, low production capacity,Telecommunication service(weak demand, high inventory and leverage) more pressureRetail sales(weak demand, high inventory) andTransportation(demand is OK, but inventories, investment and leverage are higher, and capacity is lower.) it is also noteworthy.

Outlook: under the pressure of recession, US stock earnings may continue to decline, which is expected to be 2023-5%. If the market wants to rise, it may need to be suppressed first, and it will be under molecular pressure in the second quarter.

Considering that the current financing costs of all lines in the United States have exceeded the return on investment (for example, the real yield on investment-grade bonds exceeded the actual year-on-year growth rate of GDP in November by 342bp, the spread is currently upside down by 75bp, and the interest rate on high-yield bonds was once close to 10%, which is only lower than the 30-year mortgage rate of S & P 500 ROIC 265bpX once close to 7%).So a gradual recession may be a high probability event.According to the historical experience of 3m10s spread upside down, recessionary pressure is likely to come in the first or second quarter of next year.

However, by reviewing the experience of 18 recessions since 1920, deep recessions are generally caused by high leverage, tight monetary policy, or external shocks, so as long as the Fed can stop raising interest rates in the first quarter, the squeeze of financing costs on return on investment will not be obvious.So as not to cause a very deep recession.(reviewing the historical experience, the average upside-down amplitude of 3m10s is 150bp).

In this context, U. S. stock earnings are likely to continue to fall, but the adjustment is not very large. At present, we expect earnings growth to slow to-5.5% in 2023, which is still lower than the 5.3% currently expected by the market.

Valuations that are still not cheap add up to increased recessionary pressure in the first and second quarters of next year, which may dampen the desire for US stocks to rise first.

The current 12-month dynamic Ppace E of the S & P 500 is 17.7 times, higher than the historical average of 16.2 times since 1990. The current retrenchment and the elimination of upward risks in US bond interest rates provide support for interest rates and risk appetite for US stocks.

However, under the increased recessionary pressure in the second quarter of next year, the denominator may not be compensated immediately, and after market fluctuations may force loose expectations, the rapid fall in US bond interest rates may gradually bring more opportunities for the allocation of growing stocks.

Assuming the equity risk premium rises to 2.7% of the low at the end of September and the 10-year Treasury interest rate of ~ 3.8%, the S & P 500 is reasonably valued at ~ 15 times. Our reasonable valuation based on growth and liquidity measurements is also roughly the same (48 per cent of ISM manufacturing PMI corresponds to a reasonable valuation of 14.5-15 times the 10-year US Treasury interest rate of 3.8 per cent), with implied support 10-15 per cent lower than the current level. However, we expect the year-end level to be ~ 5% higher than the current level.