Executive Summary
- Markets soared despite inflation data coming in hotter than anticipated
- Depressed positioning and sentiment helped push stocks higher
- “Pivot” talk permeated through the market as some foreign central banks intervened
- S&P 500 reporting lowest earnings growth since Q4 2020 despite massive growth from Energy
- Bond volatility remained near record highs
Stocks soared during October, with value stocks outperforming growth as earnings season kicked into high gear and Fed watch continued. The market appears to have taken some support from the idea the Fed could soon begin to scale back on the pace of its tightening program in the months ahead. With a 75bps hike essentially guaranteed for the 11/2 meeting, the focus will turn to the language used by Fed Chair Jerome Powell regarding pausing to evaluate the impacts of policy decisions to date. Futures markets are currently pricing in a 50bps hike in December, followed by another 25bps in January 2023. We also saw the Bank of Canada hike rates 50bps, less than the anticipated 75bps, while the ECB also reported some hesitancy to large hikes, so it is possible the Fed could slow its pace as well.
On a global front, the war in Ukraine continued, with Russia recently backing out of a deal to allow grain shipments from Ukraine, one of the world’s largest food exporters. If Russia doesn’t change its decision on the deal, it’s likely a rise in global grain prices could follow, causing significant problems for many counties where we have seen protests over the cost-of-living increases. Outside of the war, October also saw the end of former U.K. Prime Minster Liz Truss’ tenure, as she was forced to step down following her cabinet’s plan to debt-fund tax cuts. The plan rocked financial markets, sending the Pound Sterling to record lows and UK bond yields to post-financial crisis highs before the plan was pulled. Truss was in office for just 44 days.
Moving to Asia, we continued to see the Japanese Yen deteriorate, hitting a low of 150.15 as the central bank maintained its ultra-easy monetary policy. According to a Bloomberg report, Japan spent a record $42.4B (6.3T Yen) in October to prop up the Yen. Reports indicate that the BOJ still has some ammunition to intervene again, if necessary, but they need to keep the intervention under 2% of GDP to stay off the US currency manipulation report. If Japan does indeed need to raise cash for more intervention, it could be forced to sell US Treasuries, potentially sending yields higher.
October also saw the Chinese Yuan fall to its lowest level since 2008, despite state bank support. China has been facing increasingly strong headwinds from a faltering real estate market. Chinese policymakers have been attempting to support the slowing economy while the U.S. Federal Reserve continued to hike rates, further pressuring the Chinese currency. We first wrote about the Chinese real estate market in the summer of 2021 when China Evergrande turned sour, and it appears that was not an isolated issue. The continued Covid-Zero policy out of China also continues to have ripple effects around the globe, causing issues with supply chains but also limiting some oil demand with lockdowns.
Despite some big misses on the earnings front, it appears as though both positioning and sentiment were a bit too negative ahead of this quarter’s reports. According to this month’s Bank of America Global Fund Survey, cash levels were at 6.3%, the highest since April, and investors were underweight equities by three standard deviations. Furthermore, corporate buybacks helped push stocks higher and are on pace for a record $1.25T this year.
On a total return basis, value and small caps rose sharply, while mega-caps lagged. All 11 sectors finished the month higher, with Energy stocks by far the best performer, closing up 25.0%. Industrials and Financials gained double digits to start the fourth quarter, finishing the month higher by 13.9% and 12.0%, respectively. Consumer Discretionary and Communications were the laggards, eking out a positive return of just 0.2% and 0.1%, respectively.
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Earnings
As we move past the halfway point of this earnings season, with just under 54% of companies reporting, 71% of S&P 500 companies reported a positive earnings surprise, with 68% reporting a positive revenue surprise. The 71% earnings surprise is below the 5-year and 10-year averages of 77% and 73%, respectively, according to Factset. Companies are reporting earnings 2.2% above consensus estimates, below the 5- and 10-year averages of 8.7% and 6.5%. If the 2.2% ended up being the final percentage for the quarter, it would be the second-lowest surprise percentage in the last nine years.
When focusing on revenue, 68% of companies have reported actual revenues above estimates, below the 5-year average of 68% but above the 10-year average of 62%. The average revenue beat has been 1.7%, also below the 5-year average of 1.9% but above the 10-year average of 1.2%. The blended revenue growth rate for the S&P 500 is currently sitting at 9.3%, which, if it were the final number, would be the first time since Q4 2020 that revenue growth came in below 10%.
Energy has been a large contributor to the earnings surprises as well as growth, with an average EPS beat of 11.3% and earnings growth registering a staggering 140.3%. Earnings growth outside of Energy has been mixed so far this season, with Real Estate clocking in with 20.5% growth, followed by Consumer Discretionary at 20%, Industrials at 16.6%, Utilities at 8.9%, and Staples at 2.9%. Materials saw the weakest growth with (33.9%), followed by Communications (16.9%), Technology (5.9%), and Health Care (1.4%).
Per Bloomberg estimates, Energy companies expectedly led the way in terms of the number of companies reporting earnings surprises with 100% beating estimates, followed by Real Estate with 94%. The Materials and Communications sectors saw the least number of beats, with only 55% of companies reporting earnings surprises, followed by Health Care with 60% beats. Energy stocks reported the largest beats with an average of 48.5%, followed by Utilities with 24.4% and Consumer Discretionary at 18.9%.
The forward 12-month PE for the S&P 500 is 16.3, which is below the five-year average (18.5) and 10-year average (17.1).
In terms of price action following earnings prints, Energy stocks have seen the largest 2-day move and by a wide margin. So far this season, we have seen Energy stocks climb an average of 5.2% in the two days following their earnings print, followed by Materials which have climbed an average of 3.3%, despite their negative earnings growth. Utilities stocks rose an average of 2.2%, followed by Consumer Staples 1.9% and Industrials 1.7%. Health Care, Financials, and Technology stocks saw marginal gains below 1%, while Consumer Discretionary and Real Estate stocks fell by 1%. Communications stocks saw the largest 2-day drop, falling an average of 1.7%.
Looking Ahead
November will see the remainder of the Q3 ’22 earnings season, as well as a slew of key economic data, including the Fed’s rate hike decision on 11/2. Outside of the Fed meeting on 11/2, we will also be watching the CPI data release on 11/10, as well as Initial Jobless Claims each Thursday of the month. Energy was a detractor in the latest CPI reports, which might not happen again in the upcoming releases, but the Fed will likely be watching the services component as well as housing. As for earnings, S&P 500 Q3 earnings growth is 2.2% vs. the 2.8% growth expected at the beginning of the quarter. Ex-energy, earnings have declined 5.1%. Despite Energy being the only sector with earnings growth, Q3 results have been “less bad than feared,” which along with sentiment and positioning, has allowed stocks to gain ground in October.
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