After a Quarter for the Record Books, What’s Next?

One Down, Three to Go

As quarters go, this was one for the record books. Taking three months, or a calendar year, to have any particular significance makes no sense, but it’s difficult to quell it. So, here is an attempt to summarize what’s changed in the last three months from the point of view of markets.

Two huge shocks dominate the landscape — the sharp hawkish turn by the Federal Reserve and other central banks, and Russia’s invasion of Ukraine. These events between them naturally increased the risk of a recession or economic slowdown. They also dented hopes for earnings growth. Higher interest rates, international disruptions, and spiking commodity prices all make it harder for companies to make money.

Recession Fears Up, Earnings Prospects Down

Handily, Absolute Strategy Research of London conducts a quarterly survey of big fund managers that asks investors to put percentage probabilities on specific outcomes. Since the last quarter, the fear of a global recession has risen sharply, accompanied by falling hopes for higher earnings:

However, it’s not clear that reduced earnings expectations have found their way into market pricings yet. The desire to wait for the situation in Ukraine to clear up has probably inhibited analysts from producing new forecasts. If we look at “earnings momentum,” defined as the proportion of earnings forecasts that are upwards, then work by the quantitative team at Societe Generale SA shows that positivity is indeed declining. However, there are still barely any more downgrades than upgrades:

Meanwhile, Bloomberg’s survey of estimated earnings for all of 2022 has shown minimal change during the first quarter (outside of the energy sector) across developed markets. This chart is in local currency terms — Japanese earnings forecasts are down if we take into account the pummeling the yen has taken:

Emerging markets estimates have taken a hit, but so far the figures reported to Bloomberg for the developed world have barely changed. Where there is great confidence, however, is that earnings multiples will come down. This is a natural consequence of rising interest rates, according to the prevailing logic most investors learned at business school. The Absolute Strategy report finds fund managers braced for stocks to command a lower multiple of lower earnings in 12 months’ time. Not cheery, but logical.