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Weekly market update – What’s down is up

Daniel Morris
By DANIEL MORRIS 20.04.2023

In this article:

    The first quarter US earnings reporting season is getting underway. Companies’ results will, as always, be studied for clues as to the future direction of the equity market. Divining the lessons could be particularly challenging this time round because expectations are for first quarter 2023 earnings to have declined versus the same quarter a year ago. Uncomfortable food for thought for equity investors who would prefer positive earnings momentum.  

    An additional challenge (and the primary reason earnings are – again – expected to decline) is that profits are normalising after the boom following the end of the Covid lockdowns, when pent-up demand and inflation led to unusually high earnings. What the trend level of earnings should now be is still unclear. Analysts are hoping that this would have been the last quarter of negative earnings growth (if one excludes the energy sector). The same poor results from the last several quarters should then allow for much bigger gains as the year progresses (see Exhibit 1).

    Basis effects – Something to anticipate?

    One could question whether such a positive trajectory is reasonable.

    The most recent data shows economic growth and inflation pressures remain strong: non-farm payrolls growth exceeded market expectations, the services sector purchasing manager indices are above 50, and year-on-year core consumer price inflation (CPI) has risen compared to the previous month. Particularly now that the stress from the recent banking sector turmoil has faded, there is little reason for investors to believe that the US Federal Reserve will not continue to hike interest rates. In fact, the peak rate expected for this cycle has partly recovered from the decline last month (see Exhibit 2).

    Good for now – And then what?

    We believe that a recession will ultimately be necessary to bring inflation back down to the Fed’s 2% target, in which case earnings are much more likely to decline than rise. The timing is unclear, but as long as equity markets see positive economic growth, they are likely to gain ground. Once the impact of the increase in policy rates becomes more evident, the mood in the equity market may sour.

    Some investors have instead focused on the end of the hiking cycle as a reason to be more optimistic on the outlook for equities. We believe this is mistaken. Central banks are raising rates because growth is good and inflation is strong, factors which are positive for corporate profits. They will begin cutting rates once recession is in sight, an environment where earnings and markets typically fall. For now, however, things look good. With just 63 companies in the S&P 500 having reported, earnings growth is nearly 6%, with much-better-than-expected earnings for financials offsetting disappointing results for technology companies (as has been the pattern in the last few quarters). Surprises should remain positive, even as the actual results take a turn for the worse as more companies report.

    China – Leading emerging markets?

    Given the challenges facing the US and Europe, the better-than-expected figures for first-quarter GDP growth in China reinforce the view that emerging market equities should begin making up some of their underperformance of the last year.

    Strong retail sales data shows that this recovery of the economy is likely to be more domestic focused than those in the past, where the global spillover was more to commodity prices through increased fixed investment.

    This time it will likely be the service sectors that drive growth, as has been the pattern in other countries when economies reopened. A key international channel will be tourism, which has so far grown only slightly.


    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.

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