It has been a challenging few weeks for global equity markets. There is no single factor to blame, although inflationary pressures and the implications for central bank interest rate policies remain core issues. Below, we share some thoughts on the first quarter earnings results which are now about halfway complete.

 

Prior to the beginning of the reporting season, the number of companies that had issued negative pre-announcements – announcing results ahead of when they were expected to report – exceeded the number of companies reporting positive pre-announcements 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 estimate at the start of the reporting season. In addition, some of the upside to forecasts has been driven by profit margins, suggesting that cost pressures have not been as severe as expected (at least not yet). Nevertheless, there are clearly some industries in which 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. On average, however, the results suggest that companies are still seeing good 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 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 stocks in the world. The Technology group broadly benefited from the global pandemic, with consumers and businesses spending more on hardware, software and services for some time. As a result, the earnings and stock prices of many companies appreciated remarkably in recent years.

 

This year has brought a starkly different experience. The sector has been among one of the weaker performers, partly in anticipation of a moderation in earnings growth. This moderation has indeed been happening, with the pace of growth nearing the average of the broader markets. On its own, this growth rate is a reasonable figure, but it is far from the 40% annual earnings growth witnessed at this point last year.

There is another important factor pressuring the technology space - anticipation of higher interest rates. Stock prices tend to be driven by a discount rate that is applied to a stream of future earnings, cash flows and dividends. The rate used is heavily influenced by the level of interest rates. All things being equal, a higher discount rate results in lower stock prices, and vice versa. Higher growth stocks, like some of those in the technology sector, are particularly sensitive because of the anticipated trajectory of their longer-term cash flows (further in the future). As a result, technology stocks have been under pressure with bond yields rising and central banks expected to raise short-term interest rates rather aggressively.

 

Overall, investors should be comforted to some extent by the earnings season that has unfolded so far. The results suggest that the operating environment remains reasonably healthy from a demand perspective. Nevertheless, the results have not been enough to offset the myriad of macroeconomic and geopolitical issues that continue to confront investors.

 

Should you have any questions, please feel free to contact us.

Drew M. Pallett LL.B. CFP

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities

Email: drew.pallett@rbc.com

Website: www.pallett.ca