Consensus EPS growth forecasts have been resilient - is this reassuring or highlighting the risk that an EPS downgrading cycle is yet to commmence?
Despite the significant economic, monetary policy and geo-political induced volatility in equity markets in the first half of 2022, consensus EPS growth forecasts have been remarkably resilient. Is this reassuring or is it highlighting the risk that an EPS downgrading cycle is yet to commence?
Chart 1 shows the status of regional market consensus EPS growth forecasts for this year and next and measures the revisions (deltas) to the forecasts made at the end of last year. US growth forecasts have hardly changed over the last six months.
Chart 1: Regional consensus EPS growth forecasts
Source: Refinitiv, FactSet
The US 2022 and 2023EPS trails emphasize the steadiness in the forecasts over the last few months - showing no impact (so far) from the uncertainty and volatility of the market.
Chart 2: US Estimate trails
Source: Refinitiv, FactSet
The resilience in consensus forecasts could be providing a false sense of security. One of the key areas of concern is that analysts have a poor track record in predicting macro driven falls in EPS.
Chart 3 compares consensus12M forward EPS forecasts with trailing (reported EPS), and the forward estimates tend to follow (not lead) reported EPS down. Are analysts waiting for guidance and reported data to decline before they start reducing their forecasts?
Chart 3: Comparing US consensus EPS forecasts to reported (lagging) EPS
Source: Refinitiv, FactSet
The significant rise in input prices (both labor costs and materials) creates top-down headwinds for corporate margins. Some find it hard to reconcile these headwinds with unchanged EPS estimates.
Chart 4: US labor costs and input prices
Source: Refinitiv, FactSet
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While July saw a rally in most equity market regions (with the notable exception of China), the notable performance was delivered by US equities which outperformed the World ex US index by 5.8%.
Chart 1: Comparing regional equity returns in July (USD, TR, %)
Source: Refinitiv, FactSet
Looking at 10-year annualized returns US equities have delivered 13%, more than twice the 5.9% return from the World ex US.
Chart 2: Regional 10-year aggregate and annualized returns (USD, TR, %)
Source: Refinitiv, FactSet
The rally in the US relative performance in July saw it rebound back to levels seen earlier this year. By contrast, Emerging Market relative performance weakened
Chart 3: Relative performance charts for the US and Emerging Markets
Source: Refinitiv, FactSet
To identify the driver of US equity outperformance in July, it is useful to utilize sector weighted performance contribution analysis. Exhibit 4 compares the sector weighted contributions for the US and the World ex US indexes. The majority of the almost 6% outperformance of US equities in July was almost entirely due to the scale of contributions from the Technology and Consumer Discretionary sectors.
Chart 4: Sector weighted performance contributions US and World ex US for July
Source: Refinitiv, FactSet
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Low beta and Value were the best performing factors with momentum lagging. The "Pure" quality factor also outperformed reflecting increased risk aversion. The 16% outperformance of the Value style relative to Growth was a notable feature of the first half of the year.
The first half of 2022 produced large rotation in factors utilizing the FT Wilshire "Pure" factor methodology and data. In terms of relative performance, the Low Beta and Value Factors outperformed the most (responding to rising real yields) with the momentum factor underperforming significantly.
Interestingly the "Pure" Quality factor outperformed as well (unlike most other Quality Factor indices) - this reflects the Pure Factor methodology stripping away unintended sector and factor exposures. The outperformance of the quality factor reflected the desire to seek protection against recessionary headwinds.
Chart 1: Pure factor relative performance YTD
Source: Wilshire
Value has persistently outperformed while quality outperformed strongly in Q2. By contrast Momentum declined significantly in Q2 .
Chart 2: Relative return of Pure Factors YTD
Source: Wilshire
In terms of the size indices large and small delivered similar returns YTD with Micro cap slightly underperforming. The scale of the Value style outperformance was the key feature in the first half of 2022.
Chart 3: FT Wilshire 5000 size and style returns
Source: Wilshire
A notable feature of 2022 market dynamics has been the 16% outperformance of Value relative to Growth. The Growth /Value relative return ratio appears to be returning to pre-Covid levels
Chart 4: Growth Style Index returns relative to Value
Source: Wilshire
Index 15303321 E0922
A key feature of the sell off was the rotation out of long duration growth and tech stocks in response to rising real yields. It also produced a statistically significant decline in PE valuation.
As at the close on June 30th 2022 the FT Wilshire 5000 index delivered a negative return of -20.9% for the first half of the year. Most of the negative return was delivered by the substantial Q2 correction of -16.8% as market sentiment reacted to mounting stagflation angst and increasingly hawkish Federal Reserve guidance.
Chart 1: The largest half year correction on record
Source: Wilshire, Refinitiv
Chart 2: The correction has rewound the index back to February 2021 levels:
Source: Wilshire, Refinitiv, FactSet
However, despite the pullback US equities have still delivered strong nominal and real long-term returns measured on both an aggregate and annualized basis.
Chart 3: Strong long term Nominal and Real returns
Source: Wilshire, Refinitiv, FactSet
A significant element of the correction was driven by a rotation out of long duration growth and technology stocks as real yields increased
Chart 4: Rising Real Yields have led to Growth stock underperformance/Value stock performance
Source: Wilshire, Refinitiv, FactSet
The growth stock underperformance was dominated by the negative sector weighted performance contribution delivered by the Digital Information, Technology and Consumer Goods and Services sectors. Only the Energy sector posted a positive return contribution YTD.
Chart 5: FT Wilshire 500 Sector Weighted Performance Contributions YTD
Source: Wilshire
The correction has produced a significant and rapid PE decline - producing a rarely seen 3 standard deviation move.
Chart 6: A rapid and large decline in the PE valuation
Source: Refinitiv, FactSet
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