A key pillar of the bull case for stocks could be set to crumble, famed strategist warns

• Permabear Albert Edwards warned investors on Thursday of waning earnings optimism amid high oil prices.
• The Société Générale strategist sees potential for stagflation due to the US-Iran conflict.
• Stocks surged earlier this week on hopes of a resolution to war.

Amid all the Iran-war-driven chaos, one pillar that bulls have been able to lean on is the resiliency of earnings.

That pillar might be starting to wobble, however, according to Société Générale strategist Albert Edwards.

Forward 12-month profit estimates, which tend to be the primary driver of stock performance, were revised up again in March for the S&P 500. The rosy outlook for earnings has provided solace to investors recently — despite gas prices threatening to fuel both inflation and a pullback in growth, the cold, hard earnings numbers have been steadfast.

But Edwards, a self-styled uber-bear who called the 2000 and 2008 crashes, said in a note to clients on Thursday that this could be lulling investors to sleep, and they could be in for a rude awakening in the months ahead as earnings eventually start to roll over thanks to elevated oil prices.

"The equity market may be looking in the rear-view earnings mirror and taking comfort from such robust profits growth, especially in the Tech/AI-related sectors," Edwards wrote.

The key metric underpinning Edwards' argument is the growth of optimism in analyst earnings upgrades. While optimism is still rising, the pace of that growth appears to have topped out.

The black dotted lines in the charts below show both earnings growth estimates for the S&P 500 and the rate of change of those estimates.

"I see loads of commentary talking about buoyant US profits upgrades. By contrast I have seen only one comment (and believe you me I look at a lot of stuff) that concurs with my contention that profits momentum has begun to stall," Edwards wrote, the emphasis his. "It's the second derivative that matters here."

Slower-growing but still-positive analyst optimism might seem benign, but Edwards warned that the slowdown could signal that the earnings picture is starting to sour as investors come to grips with the inflationary and anti-growth implications of higher oil prices.

Higher inflation levels tend to push up longer-term interest rates as investors seek greater compensation. They also mean the Federal Reserve is more likely to hike short-term interest rates to cool off an economy. Both have historically weighed on stock prices.

The recent surge in oil prices seems to have foiled investors' hopes for additional Federal Reserve rate cuts.

At the same time, economists worry that high oil prices could eat into consumers' budgets, hurting growth. It's a recipe for disaster for investors: stagflation.

But some market pros think it's too early to fear such a scenario.

"You're talking about war efforts that go on for years and years that plant the seeds of stagflation," Jeff Weniger, the head of equity strategy at WisdomTree, told Business Insider earlier this week. "We're one month into this."

Stocks rallied furiously on Tuesday and Wednesday this week on prospects of de-escalation in Iran and a potential reopening of the Strait of Hormuz.

For now, though, Edwards is skeptical of the timely resolution investors are hoping for. Even if the US pulls out of the conflict, the possibility remains that Israel could continue strikes on Iran, he pointed out.

"Most commentators and investors appear to not expect this war to wreak the economic havoc some of us still remember from the 1970s," Edwards wrote. "That smacks of complacency to me."