Investors eyeing their exposure to global equities need to pay close attention to what lies ahead for stock markets after recent falls, which were especially steep after the US Federal Reserve (Fed) raised interest rates by 50 basis points in early May.
In particular, on the back of the first quarter reporting season, the outlook is nowhere near as robust as in 2021. Notably, the US has been performing worse than average, with its high weighting in technology and growth stocks counting against it.
At the same time, however, for the vast majority of companies, the business climate is still quite positive, showing strong revenue and earnings growth.
“For companies listed in the US S&P 500 stock market index, revenue and earnings have grown by a low-teens percentage,” said Frank Thormann, portfolio manager, multi-regional equities at Schroders.
Taking stock of results
Given that one of the main sources of information for equity investors about what is going on comes in the form of quarterly reporting seasons, Schroders urges them to take a closer look.
“Looking ahead to the rest of the year, earnings estimates are not being revised higher but they’re also not falling dramatically,” explained Thormann. “I’d say that’s a fairly strong achievement.”
However, the latest figures show some sectors as being more challenged, with clouds gathering on the horizon.
For example, financials saw earnings declines in the first quarter of 2022, particularly banks. This was largely because of a jump in provisions – funds that are set aside in anticipation of future losses.
“We should remember that bank losses for bad loans have been low for a very extended period, so provisions have risen from what was probably an unsustainably low level,” added Thormann.
He also believes a lot of these provisions will be relatively short lived. The big question, he noted, will be whether the Fed can engineer a soft economic landing, or whether the economy will end up in recession. “Clearly, if we end up in recession then banks could face a rise in bad debts.”
Another sector having a difficult time is manufacturing, since anything involved with making physical goods and shipping them around the world is facing a very complex situation right now, compounded by cost pressure in supply chains.
Pricing power to the rescue of stock-pickers
To find opportunities in the current landscape, Schroders considers cost pressures, and the ability of companies to pass on cost increases to customers, as a key element to focus on.
Such companies are able to weather the inflationary environment really well.
“In a nutshell, the source of ‘pricing power’, or the ability to raise prices without destroying demand, comes from having a product or service that is indispensable or mission critical,” explained Thormann.
The energy sector could also offer positive surprises to investors. “We think oil prices are likely to remain relatively robust,” he added.
Capital discipline, in terms of energy companies reining-in spending, could also benefit investors.
“That’s a concept that has been pretty foreign to the energy sector in the past. However, we’re now seeing companies refrain from increasing drilling activity at any price.
“Instead, they’re focusing on free cash flow generation, and on returning that cash to shareholders,” explained Thormann.