To my clients:

It was a down week for North American stock markets with the Canadian TSX finishing down 2.0%; the U.S. Dow Jones Index finishing down 2.5%; and the U.S. S&P 500 finishing down 3.3%.

Well, as I’m sure is a surprise to no one, it has been a challenging few weeks for equity markets. While there are several factors at play, inflationary pressures and the implications for central bank interest rate policy remains a core issue. To wit, at its meeting next week, the U.S. Federal Reserve is almost sure to raise rates by 0.50%. But this is a topic I’ve addressed repeatedly in these weekly missives as well as my most recent quarterly letter to clients. Instead, this week let’s take a look at corporate earnings and see what, if any, signal is being sent by companies themselves.

Prior to the beginning of the reporting season, the number of companies that had issued negative preannouncements – announcing results ahead of when they were expected to report – exceeded the number of companies reporting positive preannouncements by a wide margin. As a result, investors were quite cautious heading into the season, believing that companies were witnessing deteriorating demand, or rising costs, or worse yet, a combination of both.

Fortunately, the results reported thus far have been somewhat reassuring. Earnings growth for the broader developed markets is now expected to be over 10%, nearly double the original estimate at the start of the reporting season. Moreover, some of the upside to forecasts has been driven by margins, suggesting cost pressures have not been as severe as expected, at least not yet. Nevertheless, there are clearly some industries where labour, commodities, and other inputs are either in short supply or witnessing meaningful pricing pressures. This has led some companies to reduce their guidance for future earnings. But, on average, the results suggest that companies are still seeing decent levels of demand, particularly from consumers, and are finding ways to navigate through the cost pressures with a degree of resiliency.

The Technology sector is worthy of some specific discussion. Investors have been anxious about this cohort given its significance in the global market – it is the biggest sector and home to some of the largest companies in the world. This group broadly benefited from the global pandemic, with consumers and businesses spending more on hardware, software, and services for some time as a result of the work-from-home phenomenon. Consequently, earnings and stock prices of many tech companies appreciated remarkably in recent years. But so far this year has been a starkly different experience. The sector has been among one of the weaker performers, partly in anticipation of a moderation in earnings growth. That has indeed been happening with the pace of growth nearing the average of the broader markets. On its own, such a market-rate of growth is a reasonable figure… but, it is a far cry from the 40% earnings growth many of these tech companies witnessed at this point last year.

So, in sum, what we are seeing is moderating, although still healthy, market-wide earnings growth, with tech companies moderating more notably as they largely return to the growth trajectory that existed prior to the pandemic. And the growth suggested by these results is consistent with RBC’s main thesis – that recession is not imminent. If I were to sum up what is happening in the markets into a single sentence, it would be this: The rising rate narrative is reducing the amount investors are willing to pay per dollar of earnings generated in corporate North America. But earnings and, more importantly, ‘growth’ in earnings is still healthy and not set to imminently flip to ‘losses’ as would be the case in recession. In such an environment, as uncomfortable as it might be, the best course of action continues to be ‘give equities the benefit of the doubt’. Corrections are recurring phenomena in the markets, and we are in the midst of one. But they do resolve, and often do so very quickly. Further, high quality companies such as those held in client portfolios weather such storms better than average. Stay the course.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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Any recommendations herein are for the exclusive use of clients of RBC Dominion Securities and Investment Advisor Nick Scholte. Any other direct or indirect recipient of this email should consult with his/her own licensed investment advisor prior to implementing any investment action he/she may be contemplating.