Corporate earnings are fine, but estimates are no longer rising broadly
The level and growth rate of corporate earnings remain reasonably good – earnings are at record highs, and are expected to grow about 10% this year and next. However, analysts are no longer revising their earnings forecasts higher on average, halting a trend that has generally been in place since mid-2020.
The table below shows the current consensus earnings per share estimates for the S&P 500 index (based on the bottom-up aggregation of individual company estimates). While estimates are slightly higher than they were three months ago, in the last month there has been essentially no change in either this year or next year’s estimate.
CPI remains high, but commodity prices stabilizing
The latest CPI report yesterday showed prices in April still rising at a worrisome rate, led by recovery in service-related spending like airline fares. The monthly increases in the headline CPI and the core (excluding food and energy) rate were both above consensus expectations.
Notably, the core rate (+0.6%) rose substantially more than the headline rate (+0.3%), as the impact of food and energy was negative in April. However, the year-on-year increase in the headline CPI, which eased slightly to 8.3%, is still substantially higher than the core rate of 6.2%.
Fed coming late to tightening party
Yesterday’s Fed policy announcement was certainly the focus of attention, and monetary policy has been driving headlines and market action for much of the year. However, our view is that fiscal policy is likely the bigger policy force in the economy nowadays, and fiscal tightening started some time ago.
Inflation is high but could ease as the year goes on
Inflation remains a big topic among investors, and the charts below clearly show some of the reasons why, but there are also reasons to suspect inflation pressure could ease later this year.
Inflation is high . . .
A barrage of recent headlines has made it hard not to notice that reported inflation is very high (e.g. US CPI year-on-year change at 8.5%). More importantly for markets, inflation has continued to come in above expectations. The Citigroup Inflation Surprise indices (chart below) measure the degree to which inflation reports come in above or below consensus expectations. The indices for the US, Europe, Emerging Markets, and the global aggregate are all still extremely high relative to historical norms. Europe is by far the most extreme, as it is affected most directly by the war in Ukraine and the resulting impacts on energy prices and many other commodities.
Index earnings expectations for US and Europe
As Q1 earnings season gets under way, below we review the current consensus estimates for the US (S&P 500) and Europe (Stoxx 600).
U.S.
The table below shows the current bottom-up consensus estimates for the S&P 500 for Q1, Q2, and Q3 of this year.
It also shows the percentage change in each quarterly estimate from one month ago, and the expected percent growth in earnings from the year-ago quarter.
Bond market in turmoil as stocks outperform
While all markets have been volatile recently, the normally “safe” Treasury bond market has been especially volatile, and is giving mixed signals. This means that even in a generally “risk off” backdrop, the normally riskier stock market (S&P 500) has outperformed long-term Treasury bonds by a historically wide margin over the last month.
The US bond market has had a rough time lately. The ICE/BofA Long-Term (10 year+) Treasury Total Return index (i.e., which includes coupon payments and price changes) has fallen 16% from its latest November 2021 peak, and is down 23% from its latest cycle peak in July 2020 (excluding the spike in March 2020). Thus bonds are clearly in a bear market by the unscientific “down 20% or more” rule of thumb. And from a volatility standpoint, bonds are at more extreme readings relative to their normal range than stocks are, based on the VIX (S&P 500 implied volatility) and the MOVE index (Treasury bond implied volatility).
Large-cap estimate revisions holding up much better than small-caps
Our indicators of analyst earnings estimates revisions in the US highlight a key theme: revisions for large-cap (and mid-cap) stocks have held up much better recently than those of small-cap stocks.
While the proportion of analysts raising their earnings estimates relative to those cutting estimates has been declining ever since its extremely high peak in the middle of last year, the difference between large-cap and small-cap revisions has favored large-caps, and has shifted further in favor of large-caps most recently.
Why are you not more bearish?
Client Question: There is a possible world war going on along with a seemingly never-ending pandemic, inflation is at multi-decade highs, the Fed and other central banks are tightening monetary policy, and the world may lose access to Russian oil and gas entirely soon – why aren’t you massively bearish on stocks, which everyone knows is the high-risk asset class?
Answer: While naturally reserving the right to get more cautious on stocks (we downgraded equities to neutral on Feb. 14th), there are a few reasons we are not more bearish on stocks or the broader economic outlook at the moment.
Commodity prices post record surge, near-term inflation to follow
Commodity markets have become the center of global economic and financial market attention recently, showing unprecedented volatility. Russia’s invasion of Ukraine, coming on top of the volatility caused by COVID and the subsequent policy responses, has highlighted the supply constraints now facing a wide variety of commodities.
The S&P GSCI commodity price index is a widely-watched benchmark for global commodity prices, with history back to 1970. As shown in the chart below, the rolling 3-month percent change in the GSCI index has just hit its highest reading in its 52-year history. This exceeds the moves following the OPEC oil embargo of 1973-74, the 1979 oil shock, the invasion of Kuwait in 1990, the rebound in prices in 2009 after the 2008 collapse, and the rebound in 2020 from the initial COVID-driven collapse.
Market impacts of Russia’s invasion of Ukraine
While we hesitate to comment too much on the situation in Russia/Ukraine given how fast conditions are changing, many investors are naturally interested in the market impacts of the recent invasion and the resulting sanctions.
The first order impact is clearly volatility, in many different markets. Stocks, bonds, currencies, and commodities are all seeing increased volatility recently amid extreme uncertainty surrounding the unprecedented global response to Russia’s invasion of Ukraine. And of course, Russian assets of all kinds have seen their prices plunge, if they are still being traded at all — the Russian stock market has remained closed since February 25th.