Sensing market sentiment

We have gone from ‘doom and gloom’ to ‘fear of missing out’ in just four weeks. The strong retail inflows into stocks last week showed some sudden jumpiness in the investment public, which had missed most of the historical recovery in January 2023.

By now, the consensus of the S&P 500 being capped at 4,000–4,200 points is eroding as well. It would be the usual irony of a stock-market recovery if there were a brief shake-out at the very moment when everybody is warming up to the idea that the worst is over.

Hence, this week is an ideal point in time for a reality check. Last year’s main party poopers for financial assets, the large central banks, will give an update on their monetary policy stance over the coming days. For the US Federal Reserve, the futures markets are pricing in another 0.25 percentage points hike at a 100% probability. However, if anything, the rhetoric around the decision will be the real market mover. Bearing in mind that the very same futures markets are pricing in the first rate cuts in twelve months from now, this would call for some easing given the recent drop in inflation.

Granted, this is not in line with previous tightening cycles, but this one has been a very special one. As for the European Central Bank (ECB), their whole trajectory is lagging that of the US and is, by far, less aggressive given the challenges in the eurozone. We expect the ECB release to be supportive of the euro, while the recent rally in peripheral bonds (e.g. in Italy) may prove to be slightly too aggressive. Yet for the medium term, we maintain the view that low-grade bonds will do decently in Europe.

What about the earnings season?

Turning to corporates, the major ramp-up in earnings reports allows some first takes on the earnings season. Roughly 40% of the S&P 500’s market cap having reported results already. So far, corporates have largely met the subdued expectations, with 69% of companies beating expectations.

In a nutshell, it is weaker than expected but far from devastating. Taking monetary and corporate signals together, we see a fair chance for a bounce in some of the Nasdaq-listed growth names, though the strong signals come from some of the long-term laggards, such as in Europe.

Nevertheless, the Q4 beat ratio is lower than the 10-year average of 73%. Defensive sectors such as utilities and real estate are surprising most positively, while the industrials and communications sectors have the lowest beat ratio. In aggregate, earnings for the S&P 500 are beating expectations by an average of 1.5%, which also lies below the 10-year average of 6.4%. Industrials is the only sector so far that is missing EPS (earnings per share) expectations this quarter (-3.5%).

Similarly to previous quarters, the weak spot was once again in guidance, i.e. the earnings estimates produced by companies themselves. The guidance ratio, which compares the number of above and below guidance, fell to 0.4x, the lowest reading in ten months. Many companies are pointing towards the weaker macroeconomic environment in H1 2023 but expect an improvement in the second half. This is also in line with analysts’ forecasts, which are implying a temporary fall in earnings and profit margins during the first half of 2023, followed by a recovery.

What does this mean for investors?

We continue to argue that negative operating margins remain the biggest risk for earnings going forward. Companies have started to cut costs, notably in the information technology and communications sectors, but the cuts still only represent 1.7% of revenue. Given the slowdown in top-line growth, the focus is shifting from ‘pricing power’ to ‘operational efficiency’ this year.

This week will mark the busiest week in terms of earnings results. The avalanche of earnings reports will be followed by a series of crucial central-bank meetings. Needless to say, this week is not short of catalysts for equity markets.