Q1 Earnings Update
We are in the busiest part of the reporting season, with 40% of companies having reported in the US. 79% of S&P500 companies that have reported beat ESP estimates. EPS growth for these companies is broadly flat, at +1% y/y, surprising positively by 6%. Top-line growth in the US is coming in at +11% y/y, surprising positively by 2%. After a long period of bullish sentiments in the markets, earnings are now much more scrutinized by market participants and companies missing expectations have seen dramatic pull back in their stock prices.
ESP growth estimations have adjusted upwards for 2022 for most major markets and slightly downwards for 2023.
Sources: JPM, IBES *for year ending March 2023 and March 2024
While high inflation is the reason for central banks to raise interest rates, many of the factors such as higher energy prices, supply chain disruptions are not directly linked to monetary conditions or benchmark interest rates. There is however a direct link between interest rates and demand. By raising interest rates, central banks are looking to rein in demand, this comes in the backdrop of slowing GDP growth which is the reason recession fears have risen.
While fear of recession has become more elevated, the odds of a US recession is still pegged at 25%. The consensus real GDP forecasts for the US is 3.2% and 2.1% for 2022 and 2023.
If the Economy sees slow growth in 2023, stocks should be up but below trend in 2022.
Source: RBC US Equity Strategy, Haver, S&P; based on annual data through 2021
Higher fed funds rates do not necessarily spell lower valuation multiple such as the Price to Earnings ratio, however the adjustment period as the markets find their footing on valuing financial assets will be volatile and indeed painful.
During the 1990s, 10 year yields were averaging 5.3% while P/E are around the same levels as today. This shows US economy supported the same market multiple at much higher yields in the past.
Yields vs. PE: S&P500
Source: Fundstrat, Bloomberg, Daily since 1990
A history of Market Corrections
2022 has been one of the worst starts for &P500, ranking as the third worst start to a year since 1928. Continued huge losses the final 8 months are rare, with potential double digit gains quite possible. The only years the final 8 months saw stocks lower were in 1941, 1962 and 1973.
10 Worst S&P500 Index Return by the end of April
Source: LPL Research, FactSet 04/29/2022 (1928 - Current)
Looking back in history, 1987 was the last time the S&P500 was in a bear market without a recession. 1978, 1998, 2011 and 2018 all were more recent years that saw stocks nearly in a bear market but the economy avoided a recession.
S&P500 Index Bear Markets – WWII – Current
Source: LPL Research, FactSet 05/03/2022
There have been 24 corrections since World War II, with an average decline of 14.3%, while it took 133 days to find the ultimate low. The S&P500 peaked on January 2 and so far the low during the correction was on April 29 (117 days), for a 13.9% correction. (As of May 5th, 2022)
S&P500 Index corrections (WWII – Current)
Source: LPL Research, FactSet 05/03/2022
Silver lining in Fixed Income
Since the Great Financial Crisis, interest rates have been in steady decline. Real rates have been in the negative territory in recent years and this presented a great challenge for bond holders. For clients with lower risk appetite, fixed income have not been a great comfort in the ultralow interest rates environment. Since the beginning of 2022, fixed income rates have adjusted upwards with higher fed fund rates. This means fixed income investors can finally see higher rates on their bond and gic investments.
This graph illustrates the return behaviour of fixed income as rates rises or falls
Bottom line is as long as fixed income holders’ investment horizon is longer than the duration of their bond portfolio, poor near term performance will result in higher overall returns over a longer time horizon.
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.