Healthy Earnings Obscured by Market Volatility

 

We began the year with a positive outlook on the markets and general economy. This constructive outlook has not been reflected in the markets so far this year. We maintain a positive stance in stocks over cash and bonds and our optimism is rooted in the current environment of above average economic growth and strong but slowing corporate earnings outlook.

 

Tracking Q4 S&P 500 earnings

 

Approximately 33% of the S&P500 results are in for Q4 2021, the bottom up forecast for S&P500 earnings per share is still tracking at $224 for 2022 and 2023 tracing at $247.

 

Based on 33% of S&P 500 companies that have reported so far, 75% are beating Q4 earnings and 75% are beating revenue estimates. Earnings have surprised to the upside on average by 5.1%. For companies that have reported so far, Q4 revenue growth is around 16% year over year and net income growth is 25.3%.

 

Multiple – Forward PE contractions

 

The contraction in the S&P500 forward PE is in line with past Fed tightening periods. We have seen a contraction in the broader market’s forward PE of 16% since the end of 2021 – this is in-line with average drop of the market through past tightening periods.

 

There is a fear of Fed policy mistake which can end the current cycle of economic expansion. Similar to the

2004-2006 Fed tightening cycle, the current cycle is taking place in a backdrop of above average nominal GDP and earnings growth, which should provide support for PE multiple to gradually de-rate without hurting the equity market.

 

Diversification and Market Timing

 

We have seen some significant rotations in market leadership last year. Growth stocks outperformed earlier in the year and then gave away to reflation trade and value stocks. Small cap strategies underperformed as well as international markets, emerging markets in particular.  

 

Different styles such as growth vs. value, market capitalizations, and geographic diversification rotate in leadership in performance throughout a market cycle.

As the market cycle progresses, periods of underperformance are inevitable for certain strategies or diversification, even for well-regarded money managers. However, this effect diminishes with time. The odds of manager outperformance - when returns surpass benchmarks and peers - increase with time. Just as equity market returns ebb and flow over time, top managers can return to their top performance levels.

 

Diversification means while we won’t be able to fully participate in a market leading strategy, we can achieve superior and more stable results over the long term.

 

Asset class returns and US investment styles

 

In a study conducted by Baird Asset Management in 2013, by tracking a universe of 2000 fund managers, it shows top performing managers’ ability to achieve excess returns over their benchmarks increased significantly from 54% to 94% over a longer holding period.

 

Paying for impatience

 

Forecasting is difficult because there is always information unaccounted for. Certain markets and styles can underperform for a period of time, however, chasing performance can lead to missing out on the recovery and participate in the reversion to mean on a recent winning strategy.  

 

 

Rita Li works with individuals and business owners and healthcare professionals to provide tailored investment advice, risk management and financial planning. Her team comprises of professionals with in-depth taxation, insurance and legal expertise, together, they deliver a high standard of service to clients. Rita is a Chartered Financial Analyst CFA® and holds her MBA from Richard Ivey School of Business.