Stocks have a pathway to strong gains in 2023 as earning pessimism and recession concerns appear overdone

• Pessimism about 2023 earnings appears to have "gone too far," said LPL Financial in a Tuesday note.
• There are signs that pressures on earnings are easing, including a drop in the dollar's value.
• Modest cuts in earnings projections "may actually be a positive catalyst for stock prices," LPL said.

The outlook for earnings this year looks too dim as China's reopening and other factors soften the potential for a global recession, and that bodes well for stocks, according to LPL Financial.

For the fourth quarter, cost pressures from inflation, persistent supply chain issues, and sluggish growth will likely result in a 3.6% earnings decline for S&P 500 companies, the investment and wealth management firm said, citing FactSet for the figure.

"The key question to answer this earnings season is whether the pessimism surrounding 2023 earnings has gone too far … it probably has," Jeffrey Buchbinder, LPL's chief equity strategist, wrote in a note Tuesday.

"Bottom line, we would look for 2023 earnings estimates to come down, but not collapse, this reporting season," he said. "The path to a sub-$220 number for S&P 500 EPS estimates this year, if we get there, will be gradual. Modest cuts in the coming weeks may actually be a positive catalyst for stock prices."

He said there are signs that various pressures on earnings are easing, particularly from the currency front as the US dollar's value has fallen by about 9% since the fourth quarter started October 1. Dollar strength can make products from US-based companies more expensive to buy for overseas customers. S&P 500 companies generate roughly 40% of revenues outside the US, according to FactSet.

Meanwhile, US fourth-quarter gross domestic product appears on pace to exceed a 1.2% growth forecast coming from a Bloomberg survey of economists. Such expansion would arrive after the world's largest economy grew by 3.2% in the third quarter of last year. LPL said Europe's economy is also performing better than expected, largely as natural gas prices decline.

"Resilience" of the US and European economies, currency effects, and some mitigation of profit-margin pressures will be key to getting enough upside for the S&P 500 to grow earnings in the fourth quarter, said Buchbinder.

LPL said Wall Street analysts have been too slow to cut their 2023 S&P 500 earnings estimates to a "more reasonable" range of $215 to $220 a share from the current estimate of $230 a share.

But China's pullback from its strict zero-COVID policies is among the reasons that estimate cuts "may not be as drastic as some fear," Buchbinder said.

"China's reopening—uneven or not—is well underway and may be a catalyst for supply chain fixes and more global demand," he said.

Also playing their part are lower energy prices and a slowdown in wage increases which are starting to lessen cost pressures. Inflation is boosting prospects for fourth-quarter revenue growth too. Corporate America may collectively see a 5% rise in sales that outstrips the current projection of an increase of 3.8% year over year.

At the same time, companies have had "plenty of time to prepare" for what could be the most anticipated recession in history, LPL said.

"Recession may be a more than 50/50 proposition, but it isn't inevitable. The U.S. economy may 'muddle through' and skirt recession," Buchbinder said.

Stocks may find headwinds from a potential 1% to 2% hit to S&P 500 earnings stemming from tax increases in the Inflation Reduction Act, the firm said.