Last month saw investors’ apprehension regarding the slowdown in global economic growth and rising inflationary pressures wane as global equity markets rebounded from the low recorded in early October to reach a new record high.
Investors decided to look beyond these issues and supply chain disruptions as earnings results for the most recent quarter demonstrated solid growth. With almost half of the companies in the S&P500 index having reported, earnings grew 34% on a year-over-year basis while sales grew 13%1. Earnings growth was even greater in Europe, with a 44% annual gain for the Stoxx 600. There is no denying the results are impressive, but growth likely peaked last quarter. This was largely expected, as the earnings surprise factor was the lowest in a year.
Given their high expectations, investors showed no mercy to companies that missed earnings or provided disappointing guidance. In both the US and Europe, the stock price of companies that missed earnings fell the most in five years this quarter.
The longer the economic slowdown and supply chain disruption persist, the greater the risks to earnings expectations. Historically, expectations are consistently revised lower throughout the year, but the rapid economic recovery in the first half of 2021 led to significant upward revisions. Surprisingly, expectations have not budged despite the recent slowdown in activity and downward revisions to economic growth forecasts. According to Bloomberg (as of October 29, 2021) economists’ median forecasts for 2021 US real GDP went from 6.5% in the summer to less than 5.5% now. Over the same period, the consensus for 2022 US real GDP was revised downward, from 4.3% to 4%. Nevertheless, analysts continue to extrapolate strong growth in 2022 and expect the current headwinds linked to inflationary pressures and supply chain disruptions to be short-lived. This is a clear risk for the markets going into year-end.
It does not appear as though investors are overly concerned with high valuation multiples. In October, multiple expansion was behind the bulk of the equity market returns as investors pushed high valuation multiples even higher.
There are many examples of exuberance in financial markets, but one that stands out to us is Tesla. In fact, by the end of October, Tesla’s market capitalization was greater than all other OEM worldwide, even though it realized only 36% of GM’s revenues in the previous four quarters.
Global equities (MSCI ACWI Index) rose 4.9% in October in local currencies as buyers returned to the market following the largest equity drawdown since November 2020. The North American market led the way with US and Canadian equities gaining 7.0% and 5.0%, respectively. Asia Pacific trailed with a 0.6% loss as the MSCI Japan Index fell 1.2%. Europe gained 3.7% as both British and German equities lagged with a 2.3% gain. The ongoing uncertainty due to global trade and supply chain disruptions continue to weigh on the German economy, which is heavily dependent on the automotive sector.
Cheap cyclical sectors did well last month. The energy sector gained 5.8% while a strong rally in Tesla (+43.6%) propelled the consumer discretionary sector higher (+8.1%). Despite a rise in treasury yields—the US 10-year bond yield advanced from 1.49% to 1.59%—technology stocks gained 6.7%. The communication services sector was the biggest underperformer last month with a small 1.6% gain, while the defensive sectors fared only slightly better, up 2.6% for consumer staples and 3.5% for healthcare.
Considering our assessment of our three vectors—macroeconomic environment, valuation and investor sentiment—we continue to believe financial markets have run too far ahead of fundamentals and that stretched valuation and sentiment indicators leave little room for disappointment.
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