Our award-winning analyst assesses likely winners and strugglers in the face of inflationary headwinds.
Rising interest rates and their impact on the lofty valuations of big tech stocks such as Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) will be among key themes in a fascinating quarterly results season.
US corporates smashed earnings expectations during 2021 in a faster-than-expected recovery from Covid-19 – but now the comparatives are tougher and the headwinds fiercer, due to 7% inflation, ongoing supply chain pressures and the outlook for higher borrowing costs.
These pressures have fuelled jitters in the tech sector, as investors tend to rotate away from high-growth investments in favour of value and cyclical plays at times of rising interest rates.
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The FANG+ index, which is home to several of New York's most-traded tech giants including Tesla (NASDAQ:TSLA), NVIDIA (NASDAQ:NVDA) and Microsoft (NASDAQ:MSFT), is down by 5% so far this year, and the tech-laden Nasdaq is off by a similar level after rallying 21% in 2021.
Contrast this with the performance of the FTSE 100 index, which is ahead by more than 2% in 2022 thanks to London's greater exposure to resource and banking stocks.
Wall Street is increasingly twitchy about the rates outlook, with the yield on the 10-year US bond above 1.8% for the first time since the pandemic amid expectations for the Federal Reserve to hike rates four times this year from March onwards.
This means additional pressure on big tech to use the current fourth quarter earnings season not only to deliver on expectations but to forecast further strong earnings growth.
Netflix (NASDAQ:NFLX) will be the first FANG company under the spotlight on Thursday, with Apple due the following Thursday. There was a boost for the iPhone maker today when Deutsche Bank analyst Sidney Ho kept his “buy“ recommendation and upgraded his price target from $175 to $200, a level not previously reached by the world's biggest stock.
Highlighting the healthy demand backdrop and Apple's strong product portfolio, he maintained that Wall Street forecasts for 2022 revenues growth of 5% are too cautious.
He added: “While we see supply chain constraints again being a headwind to revenue, we believe the supply chain has improved at a faster pace, with iPhone wait times shortening to only a few days, and that should be enough to drive a "beat-and-raise".
Ho's point that Apple will be among those to benefit from a “flight to quality” in the inflationary environment is one that's likely to crop up throughout the Q4 earnings season.
Companies with the greatest pricing power should continue to thrive at a time when margins progress will be much harder to achieve than during most of 2021.
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According to FactSet, earnings in the fourth quarter across all S&P 500 companies are forecast to grow by an average 21.8%, which if achieved would be the fourth straight period above 20%.
Robust oil prices mean energy giants such as Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) are likely to post the strongest growth, alongside materials and industrials companies. The earnings season really gets going next week, when about a third of S&P 500 companies are due to report.
The third quarter delivered a 9% beat against expectations and Bank of America is forecasting a 3% improvement this time. After five straight quarters with a tailwind from a weaker US dollar, the bank notes that foreign exchange will have been a headwind in the fourth quarter.
It also believes that Wall Street has been too optimistic in pricing in record margins in the third quarter of 2022, given that recent upward momentum in hourly earnings is likely to stick.
Among those S&P 500 companies to report so far, labour costs and shortages have been cited most frequently as the chief factors for their negative earnings updates and guidance. Consumer sentiment and spending will also be crucial in determining the corporate outlook for 2022.
Banking giant JPMorgan (NYSE:JPM), traditionally a bellwether for the US economy, has already offered a useful guide in its results published on Friday. Chief executive Jamie Dimon said: “The economy continues to do quite well despite headwinds related to the Omicron variant, inflation and supply chain bottlenecks.
“Credit continues to be healthy with exceptionally low net charge-offs, and we remain optimistic on US economic growth as business sentiment is upbeat and consumers are benefiting from job and wage growth.”
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The question for investors as the fourth quarter season takes shape is whether the S&P 500 can justify trading on a 12-month price/earnings ratio of 21.1 times, which is above the five-year average of 18.5 times and 10-year at 16.7 times.
Higher valuations bring higher expectations, including for a step-up in the return of excess capital to shareholders through Wall Street's ongoing love of share buybacks.
UBS Global Wealth Management's Mark Haefele notes that stocks tend to perform well in the months leading up to the Federal Reserve's first rate hike, adding that the recent market weakness at the start of 2022 appears overdone.
He said: “The normalisation of Federal Reserve policy shouldn’t dent the outlook for corporate profit growth, which remains on solid footing due to strong consumer spending, rising wages, and still easy access to capital.”
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