Having studied past cycles, analysts reveal when earnings growth will hit a wall and which shares you should own now and during the next cycle.
US financial data group FactSet estimates an earnings growth rate of 61.9% for S&P 500 companies, which would mark the highest year-over-year rate since Q4 in 2009.
This spectacular rebuilding of profitability follows vaccine roll-outs and a sharper-than-expected recovery in economic confidence. This means banks in particular should be able to write-back more of their worst-case scenario provisioning for corporate and individual bad debts.
Over the coming month, however, investors will be looking beyond these headline improvements to consider whether the second quarter will be as good as it gets.
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A series of charts published by analysts at UBS today suggests that we are likely to have seen a peak in both earnings momentum and in inflation expectations. This should herald a new phase of lower returns as the rotation trade so loved by investors over the past year begins to tire and cyclical stocks surrender their market leadership to perform in line with defensives.
UBS has studied the average length of cycles over the past two decades, concluding that it typically takes between three and five months for earnings momentum to go from its peak to the point where negative returns loom.
That said, it adds that this cycle's expansion phase may be longer because of the unprecedented levels of stimulus currently in the global economy.
The analysis by UBS says that healthcare and consumer staples are the most likely sectors to benefit in the phase after peak earnings is reached. Semiconductors, banks, automotive and capital goods sectors are likely to decelerate the most, although in this cycle there might be a somewhat longer runway for financials, and especially tech stocks.
Much will depend on the strength of economic data and whether this alters the position of the US Federal Reserve after its latest meeting forecast a median of two rate hikes in 2023.
The third quarter or early in the fourth is likely to see the Fed signal the tapering of its bond buying, which UBS warns could mean a mid-cycle correction if it coincides with the unwinding of earnings momentum.
Growth stocks have held up surprisingly well since the Fed's June meeting, but UBS Wealth Management's chief investment officer Mark Haefele sees several reasons to expect the rotation into value to resume.
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In a separate note from the Swiss bank today, he said the anticipated rise in the 10-year US Treasury yield from 1.5% to around 2% by the year-end should act as a drag on growth stocks. Value investing also performs well in a period of strong economic growth, with the US forecast to expand by 6.8% this year.
Haefele said: “We maintain our preference for US value stocks and would take advantage of recent weakness to add to positions. We continue to favour sectors such as energy and financials, and we see catch-up potential in select stocks exposed to re-opening across the US, Asia and Europe.”
He also highlighted select opportunities in greentech, despite a significant cooling in the S&P 500 Global Clean Energy index since jumping 140% in 2020 due to expectations for rapid growth in renewable energy production.
Haefele points out that companies working on energy efficiency solutions, battery technology and electric vehicle components had less of a run-up than prominent renewables firms last year.
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