After the latest earnings season analysts are marking down their earnings expectations in areas including the US and emerging Asia. Revisions have turned sharply negative and are now close to levels that are consistent with actual or impending recession. US earnings per share (EPS) growth year-on-year is now expected to be flat into the first half of 2023.
Rising layoffs in some sectors of the US economy, perhaps an early sign of a softening labour market, are at odds with macroeconomic data such as purchasing manager indices.
In Europe, it is not clear that macroeconomic weakness has been fully reflected in analyst estimates, although earnings have been boosted by weaker European currencies as foreign sales are converted into local currency.
For the US, there may be more earnings downside to come. Third-quarter earnings excluding energy companies were down by 4.5% compared to a year ago. They fell by 11.5% for growth-focused index aggregates. A below-average number of results beat analyst expectations. The negative stock price reaction to such misses was the largest since 2000. To us, this suggests some investors are capitulating.
In this earnings cycle, emerging markets, and emerging Asia in particular, remain ahead of developed markets.
Europe has been resilient, with more companies beating both sales and EPS estimates than average. Banks and consumer discretionary/luxury companies have been particular areas of strength. However, analyst expectations for positive EPS growth in 2023 and 2024 may be too optimistic. For UK companies, by contrast, earnings expectations have already been downgraded significantly.
The contribution of fiscal support to growth is fading more quickly in the US than in the EU. More liquidity is draining from the US system as the Federal Reserve trims its balance sheet. Is this an opportunity to rotate out of European investment-grade credit (partially hedged) towards a modest long in US bonds? Given the difference in nature between US and EU fiscal support, different drivers of inflation (more cost-push in Europe, more demand-pull in the US), and the different expected peaks in central bank policy rates in Europe and the US, we stand pat for now.
Looking across US bond yields and futures, 60% of the US curve is now inverted, which is consistent with mounting recession risk. A super-simple measure of what equities are pricing based on their behaviour over the past 11 cycles suggests recession concerns may have fallen in the US from the peaks in late September/early October. That is in keeping with other, more sophisticated measures.
Most advanced economies appear to be moving towards slower growth and inflation, which tends to favour being long nominal USD rates as well as emerging market local currency bonds. The US economy is seeing slower growth and inflation already; Europe, by contrast, is expected to move to slower growth and higher inflation in 2023. China is expected to move to higher growth and higher inflation next year.
On China, we note that equities are trading at the lower end of their historical price-to-book ranges, with earnings and return-on-equity under pressure. Putting the ‘right’ risk premium on segments such as Chinese tech stocks may be tricky from a regulatory standpoint.
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