#56 Weekly Charts — Valuation & Earnings Estimates

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Topics of the day:

  • Valuation Style
  • Earnings Estimates

Valuation Style

New York Life Investments

Respect the macro, but invest in the micro

A shifting macroeconomic regime can create different contexts for identifying value and maintaining investment discipline. In a strong bear market, for example, this may mean having the grit to stay invested when market sentiment is poor. In a long bull market, as we saw in the last cycle, investors struggle to recalibrate fundamentals and exceed booming index returns. Today’s investment regime is neither of these. While macroeconomic forces remain highly important for tactical asset allocation, they may not be the predominant forces shaping investment returns. Instead, in our view, 2022 will be shaped by macroeconomic uncertainty, higher market volatility, and positive but lower investment returns. In this type of regime, it is the microeconomic factors — where high-level themes meet business reality — that will likely shape investment performance. Traditional style boxes like “value vs. growth” or “small caps vs. large caps” may cede influence to sector positioning, company business models, and management experience.

Wells Fargo Advisors

What to expect in 2022

We believe the key factors in 2022 are earnings growth and the rate of change in both interest rates and inflation. These are generally the building blocks for equity valuation, hence our “Back to Basics” title. We believe earnings per share should be solid in 2022 with the Wells Fargo Investment Institute projecting nearly 10% year-over-year growth for the S&P 500. Higher inflation has already been observed in areas such as labor, procurement, and freight, and there is a relatively high degree of uncertainty as to when these headwinds may normalize. We believe companies with strong pricing power will largely be able to pass these higher costs along to customers in an effort to preserve margins. Meanwhile, the potential for modestly higher rates could act as a tailwind for certain sectors while also impacting valuation models for certain types of companies.

As the economy and market exit the earliest innings of the recovery, we believe that high-quality sub-industries and companies could resume their outperformance. Quite simply, the recent run of explosive economic growth created a rising tide that lifted most, if not quite all, boats. If this normalizes as we expect, we believe investors could increasingly embrace companies with strong quality metrics — high margins, clean balance sheets, consistent cash flow generation, and the ability to grow into secular trends. We would note that growth stocks now compose an increasingly high percentage of companies that would fit this bill. Somewhat higher interest rates could be a modest headwind for valuations, and while we acknowledge this cross-current, we think the persistent earnings power within many high quality sub-industries likely wins out. Our subindustry recommendations are largely consistent with this view, and we recommend investors consult each sector-level text for more expanded thoughts.

LPL Research

What lies ahead in 2022

We do not expect 2022 to simply be a repeat of 2021. We’ve moved further toward the middle of the economic cycle, inflation is likely to decrease rather than increase, and economic momentum will probably slow. But perhaps most importantly, the policy support from central banks and governments that have helped global economies bridge the economic fissures left by COVID-19 will likely begin to fade, leaving the economy to stand increasingly on its own two feet while putting more emphasis on the aggregate decisions of businesses and households.

Earnings Estimates

RIA Advice

Estimates are extremely optimistic

Despite economic growth weakening as inflation increases, liquidity reducing, and profit margins under pressure, analysts continue increasing their earnings estimates. Currently, estimates for the Q4–2022 are $219.87/share according to S&P, up from $207/share at the end of 2021. As shown, that level will exceed the historical 6% exponential growth trend, which contained earnings growth since 1950, by the most significant deviation ever.

The only two previous periods with similar deviations are the “Financial Crisis” and the “Dot.com” bubble.

The “Sugar High Reversal”

The “sugar high” of economic growth seen in the first half of 2021 resulted from a massive deficit spending surge. While those activities create the “illusion” of growth by pulling forward “future” consumption, it isn’t sustainable. Importantly, profit margins will follow the reversal of that liquidity.

Before falling victim to the “buy the market because it’s cheap based on forward-estimates” line, make sure you understand the “what” you are paying for. Earnings are a derivative of economic growth over time. What consumers “spend” in the economy drives revenue and earnings. As economic growth slows, so will earnings growth rates.

Credit Suisse

From an investor’s point of view, 2021 has proven to be rewarding, with equity markets again generating double-digit returns. Earnings growth has been strong, with MSCI AC World earnings even surpassing pre-pandemic highs. We believe that earnings should remain the key driver of equity returns in the year ahead, enabling equities to deliver sound, though somewhat lower, single-digit returns. Since fixed income as an asset class continues to deliver only meager returns, we believe investors should look to investment strategies that follow non-traditional patterns to diversify their opportunity set further.

Asia’s reopening baton has passed from North to South as Southeast Asia (SEA) emerges from its COVID-induced malaise. The gathering pace of the vaccination rollout is allowing SEA to gain a firmer footing on the path to recovery. But these are early days still and we prefer to wait for upgrades to earnings projections before repositioning for a more sustained outperformance. Still, the signs are hopeful.

In what might be a prelude of things to come, Asia’s equity markets in 2021 — especially in H2 — reversed the relative regional performance of 2020, as SEA markets significantly outperformed China’s equities. The key difference for SEA is its newly adopted approach of “living with COVID,” which reduces the risk of episodic lockdowns. New COVID-19 cases in most SEA countries are on a downward trend as governments have been accelerating their vaccination programs.

Key risks for global equities in 2022

There are a number of risks for global equities in 2022. One risk to earnings (i.e. margins) is rising input costs, for example for commodities or wages. Another related risk is further disruptions in supply chains, a factor that started to weigh on some companies’ profitability in the second half of 2021. Inflation was also a risk for this asset class in 2021, although most market participants expect that the current elevated inflation levels will be transitory. However, stickier-than-expected inflation could lead to tighter monetary conditions and increase the risk of a policy error — both of which would be headwinds for global equities. Additionally, we believe there is less room going forward for fiscal stimulus, which has been a supportive element for equities during the COVID-19 crisis.

My conclusions and considerations

Valuation Style

  • It is ending the low interest rate policy by Central Banks and the inflation is one of the key drivers to keep in mind in 2022 and for years ahead, I think.
  • In my view in this scenario as I said before is naturally to think that there will be sectors that will benefit more than others.
  • The key factors in 2022 are earnings growth and the rate of change in both interest rates and inflation.
  • Earnings per share should be solid in 2022 with the Wells Fargo Investment Institute projecting nearly 10% year-over-year growth for the S&P 500.

Here you can find other articles about it:

  1. Annual Returns and Declines
  2. Inflation winners and losers
  3. Long Term Out-performance

Earnings Estimates

  • Well, the estimates are growing as we can read, but even here I think that as always there will be sectors and sectors to take in consideration in this precise context.
  • Estimates for the Q4–2022 are $219.87/share according to S&P, up from $207/share at the end of 2021.
  • One risk to earnings (i.e. margins) is rising input costs, for example for commodities or wages.

Here you can find other articles about it:

Join the conversation with your own take on these topics in the comments below.

About the Author

Alessandro is a Financial Markets enthusiastic and he loves learning from articles/papers on many financial topics and in doing so he shares with you the most interesting charts and comments.

Disclosure

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This material has been prepared for informational purposes only. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.