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.
Macro events overshadow a positive earnings season
With macro events dominating the headlines (Ukraine, Fed, oil), along with a high-profile “blow up” or two (i.e., Meta, PayPal), it is perhaps not surprising that there has been less attention lately on the overall Q4 earnings season results. And while almost any earnings season might seem disappointing after the string of blockbuster quarters from late 2020 through 2021, the reports for Q4 2021 have in fact been reasonably good overall. Thus far, the company guidance has been sufficiently supportive that analysts are still raising estimates for this year and next, a contrast to the usual pattern of trimming calendar year estimates over the course of a year.
Sector estimate revisions led by Technology, Energy, and Real Estate
Earnings estimates in the US continue to rise overall, helped by the continued solid economic backdrop, but the pace has eased from last year’s extraordinarily positive levels and divergences among sectors are more visible now.
Part of our sector analysis includes monitoring the aggregate earnings estimate revisions trends for the 11 GICS sectors as well as the more granular industries (we track 62 in the US currently). One of the key metrics is what we call “revisions breadth”, which is the net proportion of analysts covering a stock who have most recently raised their earnings forecasts versus those who have lowered estimates. Thus breadth readings can theoretically range from +100% (if all analysts are raising estimates) to -100% (if all analysts are reducing estimates). Thus higher is better on revisions breadth as it indicates the fundamental news is broadly improving within a sector.
Earnings expectations for 2022
With 2021 now in the history books, earnings reporting season for Q4 and the full year is set to begin soon. Below we update the current consensus earnings outlook for Q4 as well as the coming year for the S&P 500. We also drill into expectations for sector earnings growth for this year.
The bottom line, so to speak, is that analysts expect solid but more moderate growth in earnings of about 9%, led by gains in the Industrials and Energy sectors, with Financials and Real Estate the only sectors expected to show declines in earnings this year.
Energy sector supported by recovering output and elevated prices
We remain overweight the Energy sector, as analysts continue to raise earnings estimates and the sector is very favorably valued, though the picture has become somewhat more mixed as crude oil prices have been volatile recently. News of the new Omicron variant of COVID-19 and corresponding constraints on international travel have renewed concerns about fuel demand, while OPEC’s decision to go ahead with output increases has reduced the earlier concerns about insufficient supply.
Time to take profits in Financials?
As Q3 earnings season gets underway, stocks in the Financials sector are in focus as they are typically among the first to report earnings. While history indicates companies are on average likely to beat Q3 estimates, our indicators, which have been supportive for Financials all year, are now starting to weaken and suggest it might be time to take profits in the sector and reallocate to other areas.
Q3 earnings should be good, but uncertainty remains high
As Q3 ends and with reporting season set to begin in the coming weeks, we can update the current consensus earnings outlooks for Q3 and Q4 as well as calendar year 2021 and 2022 for the S&P 500. Earnings should be up a lot from last year, but uncertainty among analysts remains quite high.
For Q3, S&P 500 earnings are expected to be up 28% from a year ago according to Factset, another big percentage gain. That figure is higher than it was at the start of the quarter (it was 24% on June 30th) but has been stable since July and down marginally since the end of August. So the pace of gains in aggregate index earnings has eased, but estimates are still rising modestly on balance.
Emerging Markets fundamental momentum still very weak
In our regional allocation work, we have been underweight in Emerging Markets relative to developed markets since May, and remain so currently. A key reason for our continued underweight stance is that the relative fundamental momentum for emerging markets remains very weak compared to that of the broader global equity market.
The chart below shows one of our popular composite indicator charts based on the relative performance of the widely-followed MSCI Emerging Markets ETF, ticker EEM, versus the broad global benchmark of the MSCI All-Country World Index (ACWI) ETF, represented by ticker ACWI.
Analyst uncertainty still high even as earnings estimates surge
As we have discussed for some time now, equity analysts are raising their forecasts for corporate earnings more broadly and by larger amounts than at any previous time in our 20-year data history. However, while analysts are confident earnings are rising, they still show significant uncertainty about the future level of earnings, as reflected in the dispersion or disagreement in estimates for US companies.
Cyclical sectors still have the fundamental momentum
One of the biggest questions we have been getting from clients is “is it time to rotate out of Cyclical/Value sectors toward Growth (or Defensive) sectors?”. Based on our measures of fundamental earnings momentum and macro views, our answer is “not yet”.
There has certainly been rotation in relative returns among Cyclical/Value and Growth sectors recently, along with worries about when the Fed or fiscal policy will shift to a less supportive stance. Our view is that corrections or consolidations after large gains (on an absolute or relative basis) are healthy and to be expected, and that is likely what we are seeing in the Value/Growth relative performance recently.