Could Russia derail the earnings bull market?
Sauro Locatelli CFA, FRMTM, SCRTM Director of Quantitative Research | February 25, 2022
While global financial markets are reeling from the latest geopolitical events in Eastern Europe, earnings season for Q4 2021 is quietly drawing to a close, with over 90% of companies in the S&P 500 having already reported. The preliminary results, which at this point are unlikely to change much, show earnings 29% higher than the same quarter a year ago, which is almost 6% higher than analysts were expecting. From a sector perspective, late cyclicals such as Energy (N.M.[1]), Industrials (102.9%) and Materials (56.8%) contributed the most to the 2021 earnings surge, staging an impressive rebound after a disappointing 2020. Meanwhile, defensive sectors such as Utilities (7.1%) and Consumer Staples (6.2%) lagged behind. Going forward, analysts expect the earnings expansion to last for at least another two years, with S&P 500 earnings per share growing from $208 in 2021 to $225 in 2022 and $248 in 2023. This implies a slower but much more sustainable growth rate of around 9% per year.
As terrible as the events currently unfolding in Ukraine are from a humanitarian perspective, they are unlikely to affect the earnings outlook for the S&P 500 in a meaningful way. First of all, Russia and Ukraine are two very small players in the global economy. Based on 2020 GDP numbers provided by the World Bank, Russia contributes 1.75% to global GDP while Ukraine contributes only 0.2%. As such, even a severe and prolonged economic recession in these two countries would barely put a dent on global GDP, which is expected to grow by 4.1% in 2022. The impact for S&P 500 companies may turn out to be even smaller given the relatively limited ties between the US and the two Eastern European economies. Out of the 462 companies of the S&P 500 that have reported Q4 2021 earnings so far, as many as 18 have mentioned Ukraine on their earnings call. While that is the highest number since the peak of 40 in Q1 2014, it still amounts to less than 4% of companies in the index. By contrast, 72% of S&P 500 companies have cited inflation on earnings calls over this same period. The relatively small number of S&P 500 companies mentioning Ukraine is explained by the limited revenue exposure of these companies to Russia and Ukraine. According to FactSet, the combined revenue exposure of S&P 500 companies to Russia and Ukraine amounts to about 1%. Consumer Staples is the S&P 500 sector with the most exposure, with about 1.5% of the sector’s revenue last year coming from Russia. For most S&P 500 sectors, exposure to Russia and Ukraine is negligible.
Source: FactSet, as of 2/18/2022
[1] Earnings growth not measurable due to earnings being negative for this sector in 2020. Sales for the Energy sector grew 91.5% in 2021
History says geopolitical events lead to short and shallow selloffs
Richard Barrett, Chief Investment Officer | February 23, 2022
Here’s a fairly comprehensive list of geopolitical events dating back +80y. Consistent with last week’s TalkingPoints – What do geopolitical events mean for stock returns? (2-14-2021), negative/stressful/upsetting geopolitics events develop over the course of a few weeks, lead to sell-offs in risk assets in the range of 5-10%, and generally recover as quickly as they went down. Not trying to downplay some very negative moments in American history here – just trying to draw a circle around what those moments have meant for markets.
Three things I like in the market right now:
- Corporate earnings have been very good/great. Top line revenue growth for 4Q of +16% and EPS growth for 4Q of +26% YoY.
- Investor sentiment has been obliterated. Sentiment as measured by either bull/bear ratio, put/call ratio, fund manager survey – you name it – all flashing extreme pessimism. Advanced markets NEED to climb a wall of worry.
- More and more talk about the Fed going slower when it comes to 2022 rate hikes than two weeks ago. The yield curve hasn’t steepened yet – but it should going forward. That’s something big to watch.
Source: JonesTrading LLC as of February 22, 2022
What do geopolitical events mean for stock returns?
Sean Dillon CMT, CFTe®, Vice President of Investment Strategy | February 14, 2022
Fears of a major conflict between Russia and Ukraine/NATO intensified over the past week as White House officials urged all U.S. citizens to leave Ukraine as intelligence suggests ‘major military action very soon’. Of course, diplomacy can, and we hope, prevail but in case it does not we wanted to look at the effects war has on the stock market. The conclusion is stocks tend to have drawdowns but that the old adage ‘sell the rumor, buy the news’ is the historical pattern.
The study below from LPL Research shows drawdowns and days until recovery (the length of time to recover all losses from the drawdown). S&P 500 drawdowns tend to be very shallow with the average drawdown of 4.6%. There were a few outsized losses with 2001 and 1990 standing out but those were during recessionary economic periods, and right now our economy is very strong. With the small losses, the recovery time to recoup the losses was also very small at 43 days on average.
Additionally, we analyzed data from Ned Davis Research on forward S&P 500 returns from the event date. On average, the S&P 500 gained 5.10% over the next 63 days and 8.35% over the next 126 days.
This is not meant to downplay the seriousness of this situation. Specifically with Russia, there could be major disruptions to commodity markets, and energy markets more precisely, which could cause greater drawdowns than the historical averages. However, analyzing historical periods of conflict equity markets tend to take it in stride as the advancing economic locomotive and earnings growth win out.
Report from the (earnings) front
Sauro Locatelli CFA, FRMTM, SCRTM Director of Quantitative Research | February 8, 2022
With 56% of companies (worth 73% of market capitalization) of the S&P 500 index having reported results for Q4 2021, it is shaping up to be another remarkable quarter for corporate America. Compared to the same period last year, sales for S&P 500 companies are coming in 16% higher, while earnings are coming in a whopping 27% higher. This implies that profit margins have been rising, which is no easy feat with inflation running at a 40-year high, and suggests companies retain strong pricing power. If these numbers hold through the end of reporting season (and estimates suggest they may even improve), then this would be the fourth straight quarter of earnings growth above 25%. The last time this happened was between Q4 2009 and Q3 2010, not surprisingly at a time when the economy was recovering from another severe recession.
While that record is likely to end at four quarters once again, earnings growth is expected to remain very strong going forward. Despite all the equity volatility so far this year, analysts haven’t turned any less optimistic on the outlook for earnings. In fact, forward-looking estimates have actually increased since the start of the year. The latest bottom-up estimates point to earnings growing by about 10% per year over the next two years. While that is much lower than the unsustainable 25+% growth we have enjoyed over the last four quarters, it is much higher than the long-term average earnings growth rate of about 6% per year. Given a backdrop of a synchronized global reopening, plentiful liquidity, strong consumers and no recession in sight, we see no reason why those expectations should be disappointed.
Source: FactSet Research Systems, as of 2/4/2022
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