Rudi's View | Oct 13 2022
In this week's Weekly Insights:
-Corporate Profits Will Show The Way
By Rudi Filapek-Vandyck, Editor FNArena
Corporate Profits Will Show The Way
Is the Federal Reserve ready to take its foot off the pedal and hike interest rates at smaller increments?
The strong response that followed the surprisingly "dovish" rate hike from the RBA last week instantaneously shows why investors globally and here in Australia are keen to find out the answer, and the exact timing of the central bank's "pivot".
Most forecasters still think central bank tightening will at least continue until the end of 2022 but a slower pace, a pause maybe, will likely be taken as a positive for risk assets that have had a rough trajectory these past nine months.
Surely, those pesky inflation numbers must peak at some point, and start trending downwards?
Among investors and commentators in the US, this is the debate of the moment. If not next month, then when? Plus: if not to save the US economy from recession next year, maybe then to save the global financial system which is showing up its fragility here and there?
It's this to-ing and fro-ing, switching between hope and disappointment, that has made September the most volatile month in a long while. Measured by daily index movements of at least 1%, September offered 4 positive and 8 such negative days out of a total of 22 trading sessions throughout the month.
October started strongly as hope never genuinely dies, but disappointment has quickly followed.
Most commentators I read don't think Powell & Co are as yet ready to follow the RBA's example, even though system fragility will be on the Fed's radar.
Last week's statement from the RBA suggests Philip Lowe's board is concerned about global stresses and Australian households, but US households carry (a lot) less debt and the Federal Reserve can move a few mountains if it has to if/when the global financial system requires plumbing.
I do think there is a clear and present danger with investors almost solely concentrating on central banks' signals and intentions, at a time when corporate earnings should be on everyone's mind.
Then again, this might change soon, and not necessarily for the better.
US Corporate Earnings In Focus
Corporate earning season in the US for this year's third quarter starts at the end of this week. This time around there have been a number of warnings already the pressure from slowing growth, inflation, higher yields, a stronger US dollar and significant tightening from central banks is starting to make an impact.
Companies including FedEx, Apple, Tesla, AMD and Nike have all disappointed or pre-warned recently, as did Samsung outside of Wall Street. If these early disappointments prove indicative of what lays ahead, investors should expect ongoing bouts of volatility, this time driven by corporate "misses" and downgrades to growth forecasts.
When we zoom in on those forecasts for the current financial year and beyond (see chart below) a rather odd picture emerges: since 2008 only on one occasion has EPS growth for S&P500 companies come out at bang on the long term average of 8%, yet this is exactly what current forecasts imply for this year and the two years ahead.
I think what we are witnessing is a classic example of converging forecasts around a "safe" middle-of-the-road assumption when nobody is quite certain what to make of next year's conditions. In other words: neither the analysts behind those forecasts, nor the business leaders providing them with guidance and input, know how to quantify trends and conditions in a slowing, recessionary environment that has yet to reveal itself.
Yet, by all accounts, the chances for an economic recession in the US, and elsewhere, next year have only increased, and are still increasing. US treasuries have never been inverted to the extent they are today, and for as long as they have to date, without an economic recession following.
Market analysts at Longview Economics pointed out recently the Conference Board's leading indicator for the US economy is currently at a point below zero where it has proven to be a false signal on only four occasions post the 1960s. However, on each of those four occasions the recession was avoided because the Federal Reserve provided support and stimulated economic growth.
This time around the Fed is still tightening, and of the intent of continuing to tighten until there is a clear trend reversal in consumer price inflation.
Let there be no mistake: the narrative that current forecasts are too high and need to be culled over the weeks if not months ahead is by now pretty much generally accepted among Wall Street firms. The big debate that is left is how much leverage-to-the-downside should one account for?
Is -10% enough? Or should it be -15%? More maybe?
One complicating matter is that US indices are still very dependent on what happens next with the so-called Megacaps of Alphabet, Meta, Tesla, Microsoft etc. This part of the market still hasn't fully caught up with the rest to the downside. History suggests this is likely still to happen.
The other observation from history is that if earnings forecasts are being reduced by a noticeable magnitude, share prices usually follow suit. This is why the more bearish marketwatchers believe US indices can still have -10%-15% downside from current levels.