Earnings turning?

4 min read 15 Jul 22

Summary: Markets provided few safe havens in June, with the dual threat of inflation and slowing economic growth weighing on sentiment. With much already priced in, have markets found a floor? Investment Specialist, Kirsty Clark reviews recent market performance and comments on earnings growth expectations as we head into another earnings season.

June was another merciless month for both equity and bond markets as investors weighed the dual threat of rising inflation and slowing growth, and as the prospect of recession increasingly weighed on sentiment.

A relief rally in the second half of the month helped to stem equity market losses, but the MSCI AC World Index still finished the month down more than 8%. Global growth marginally outperformed Global value, and large caps were relatively resilient versus their smaller cap counterparts.

All major regions and sectors finished the month down. European equities were among the hardest hit, particularly the German DAX. Chinese equities bucked the trend, delivering positive returns and helping emerging market equities outperform developed market equities in the month.

Source: Refinitiv DataStream, 30 June 2022. Total Returns in USD.

At a sector level, having led the gains year-to-date, energy stocks led equity markets lower in June, with materials and technology stocks (especially semiconductors), and US and European banks, also among the weakest performers. Traditionally-defensive sectors such as healthcare and consumer staples were the most resilient.

There were also few safe havens in the bond markets, with high yield and investment grade corporate bonds seeing some of the largest declines. In commodities, Brent crude and gold finished marginally down. The dollar index strengthened and the Japanese yen continued to weaken against a basket of currencies.

Year to date through 30 June 2022, the MSCI AC World index has fallen more 20% (total returns in USD terms) – dropping below the threshold that typically characterises a bear market – and recording the largest first-half calendar year drop on record for the index.

Still, consensus earnings forecasts have remained relatively resilient to date, so while a lot has been priced in by the markets, there is still potential downside risk from here should we see substantial cuts to 2022e earnings forecasts.

Since the beginning of the year, we’ve seen a pick-up in 2022 consensus earnings growth expectations across all major regions. For the MSCI AC World Index, we’ve seen an increase from 6.8% at the start of 2022 to 11.3% now[1]. This is being driven by a handful of (predominantly commodity-related) industries, not least energy, as oil and gas prices have soared prior to the recent pull back.

Source: Refinitiv DataStream, 15 July 2022.

However, while markets look to be anticipating some of the likely earnings disappointments to come given the headwinds facing the global economy – softening demand amid rising inflation, slowing global growth, lingering supply bottlenecks, monetary policy tightening and geopolitical tail risks – current consensus earnings estimates still seem on the optimistic side with further room to fall in our opinion.

Last year’s earnings upgrades tracked alongside the sizeable rebound in global economic growth, but the positive EPS (earnings-per-share) momentum this year sits alongside a backdrop of slowing economic growth.

Notably though, earnings revision ratios (ERRs) have started to turn in the last month or so, and taken a further leg down in July. 

Source: Refinitiv DataStream, 8 July 2022.

We’ve seen some of the largest downward revisions in the US but, increasingly, in Europe amid a sharp drop in business confidence. Further restrictions on Russian energy supplies in Europe poses an additional downside risk, and could weigh on the manufacturing sector in particular.

Earnings expectations for the emerging markets have been more subdued, impacted by extended lockdowns on the back of China’s zero-COVID policy (which saw China narrowly escape economic contraction in the second quarter versus last year). Revisions have improved on the back of the reopening boost, but aggregate ERRs remain negative.

As we head into the second half of 2022, much has been priced in by markets, but more sizeable downward earnings revisions could see share prices take another leg down from here. As we mentioned in our recent quarterly outlook, the second-quarter earnings season could be a great leveller as we head into year-end. While quarterly earnings in aggregate will likely remain largely intact, investors will be keeping a keen eye on guidance for the remainder of the year.

By Kirsty Clark

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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