Sunset on Q3 2022 earnings season

The last few weeks were eventful for global equity markets as the world’s largest companies released their financial figures for the third quarter. Overall, results were better than feared even though companies were facing extremely tough year-over-year comparisons amid a deteriorating macroeconomic backdrop. Nonetheless, companies that missed the low projections set by markets were severely punished.

In the US, seven out of the eleven sectors of the US economy are on track to post negative earnings growth, with the S&P 500 marking its slowest pace of annual profit growth in two years. What is more concerning, however, is that a growing number of industry leaders are starting to downgrade their future guidance as management teams brace for slowing consumer demand and narrowing margins.

Yet, despite this overall poor performance, major US indices are currently trading at higher levels relative to the beginning of the earnings season, with the broad S&P 500 Index having rallied by over 12 per cent since mid-October. This positive market response is most likely attributed to a relief in investor sentiment that the original bearish earnings scenario did not materialise. In addition, market participants have recently revived their expectations that the Fed will be forced to pivot soon, pressured by increasing signs of weakening consumer demand, while most firms are discounting a recession in their future guidance.

The latest earnings season also reaffirmed that value shares outperform growth in periods of economic distress. Specifically, tech giants were under pressure as they appeared to be unable to sustain their spectacular pre-pandemic performance, with Amazon and Meta both dropping around 20 per cent immediately after their earnings release. At the same time, the big energy companies have crashed estimates even though oil and natural gas prices are currently trading far below their peaks for the year. 

It is common knowledge that rising interest rates directly reduce the value of companies’ future cash flows, which is an extremely negative development for growth shares as their performance heavily relies on future profit expectations. Moreover, high interest rates could discourage borrowing, reducing companies’ cash flow for investment and development spending. Besides that, tech giants’ financials got a hard hit from the slowdown in the advertisement business, hinting that companies are cutting down non-essential costs in the eye of an approaching recession.

On the other hand, defensive sectors such as consumer staples and energy are continuing to fare well due to their ability to pass on higher prices of essential goods to consumers. Energy giants were by far the biggest outperformers as supply in oil markets remains tight, while governments have not yet imposed any windfall taxes on their excessive profits. Interestingly, even though ESG has been one of the major themes in the last couple of years and most governments have intensified their efforts for a quick transition towards clean energy, oil equities are currently trading close to all-time high levels.

Looking ahead to the fourth quarter, analysts expect a year-over-year decline in earnings according to data provided by FactSet. This would mark a deviation from the eight consecutive quarters of earnings growth reported by the Index. However, analysts in aggregate not only expect earnings growth to return in the first quarter of 2023, but also project that the Index will report year-over-year earnings growth in all four quarters of 2023.

Disclaimer: This article is brought to you by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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