Investment Comment
4th November 2022
Stick ‘em up
This week interest rates were raised by both the Federal Reserve and the Bank of England by 0.75%. But the messaging was distinctly different. Whilst the official statement from the Federal Reserve in the US indicated that the interest rate cycle may be coming to an end, Chairman Powell’s comments struck a hawkish tone which depressed equities on Wednesday and Thursday.
Powell’s comments after announcing the decision to raise rates, highlighted that interest rates in the US may be higher than previously expected. How quickly the peak of inflation enables the Federal Reserve to ease back on tightening will be key to boosting investor risk appetite.
The Bank of England Governor, Bailey, indicated that rates may not be going up as high as previously anticipated. The most striking chart released from the Bank of England was its projection of inflation, which they now see below 2% in 2024, but remaining over 10% for the next 6 months.
The contrasting messaging of the Federal Reserve and the Bank of England over the pace and path of interest rates was felt most acutely by further declines in Sterling, which dipped a further 2% versus the US Dollar on Thursday post the Bank of England update.
Bank of England inflation forecast suggests a sharp drop of inflation in 2024
Source: Artorius, Bank of England
Earnings evolution
The evolution of corporate earnings in the US and elsewhere have provided colour to the economic story. In the US, companies report quarterly, whilst elsewhere the timeframe depends on the company, either quarterly or semi-annually, so updates from the US provide a cleaner comparison and often set the basis for commentary.
In the US, companies are facing a twin headwind of a slowing global economy and a stronger US Dollar. The latter reduces the relative value of sales made in foreign currencies when they are converted back into Dollars for quarterly financial reports. Measured against a group of other developed-market currencies, the Dollar rose 17 per cent in the first three quarters, reaching its strongest level in more than 20 years. Given that 40% of sales from US companies are made overseas, companies are running hard to standstill against the tide of the strong Dollar to generate profits growth from overseas sales.
The flipside of the strong Dollar is weak currencies elsewhere, such as Europe. The weakness in the Euro may explain why European earnings reports are generally holding up better than the US, despite having a weaker economic backdrop.
US Earnings Per Share forecasts are moving lower for all years, and may have further to fall
Source: Artorius, Bloomberg
Whilst in Europe, the weaker Euro is supporting the 2022 numbers, but 2023 is coming under pressure
Source: Artorius, Bloomberg
The details of the Q3 earnings reports reflect quite a wide discrepancy even within sectors. Meta (Facebook) had a very poor update, whilst Amazon exceeded estimates for Q3 but guided lower as they see a poor end to 2022, resulting in a sharp share price fall.
Apart from the Energy sector all sectors have seen a downgrade to the expected profit margin in Q3. Profit margins remain above long-term averages, and analysts expect profit margins to recover in coming quarters. We think that this is doubtful, so suggest that the upbeat Earnings Per Share (EPS) forecasts for 2023 may be revised lower in coming weeks and months.
Looking at the Q4 earnings estimates, they have fallen over the past month. Having expected 4% growth at the end of September, analysts now expect 0.5% growth. Revenue growth has only moderated from 6.3% to 4.9%.
Many investors use the US 12-month forward EPS estimate for valuation purposes. This has eased back 3% from the June 2021 highs. The S&P 500 has fallen much further, down 18% year to date. As a result, the valuation of the US market has become more attractive, falling from a 22x to 16x Price-to-earnings ratio. If historical patterns are followed, the projected long-term expected returns from investing into equities has improved as valuations have fallen.
US mid-term elections
The US electorate gets the opportunity to reshape their political landscape in the mid-term elections for Congress on Tuesday 8th November. It is likely that the Republicans will regain the House of Representatives which will stymie the ability of President Biden to enact his Democrat agenda. At the margin the prospect of no further increases in tax and regulation are likely positive for equity investors.
Gerard Lane Chief Investment Officer
Artorius provides this commentary in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 4th November 2022 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
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FP20221104001 EXP16/12/2022