When it comes to the prospect of a recession, and a possible prolonged period of stagflation, the jury is still out, even in Europe. Although in agreement on a deteriorating economic outlook, major asset managers such as BLI, Pictet and JP Morgan hold diverging views on what’s next. For investors, corporate earnings are now seen as the next waypoint.
Swiss asset manager Pictet said that the return to equilibrium will depend on the duration of inflationary pressure and the ability of companies to increase their prices. “The risk is that companies will publish very cautious first quarter results with downward revisions on profitability or growth for this year,” it said in a note to investors.
‘Heavy impact’
Guy Wagner, chief investment officer and managing director at BLI - Banque de Luxembourg Investments, said the growth potential for 2022 has been undermined by a reduction in government spending from last year’s high levels and the general rise in prices, exacerbated by Russia’s invasion of Ukraine.
“In the eurozone, GDP growth estimates are being considerably revised down due to the heavy impact of soaring energy costs on household purchasing power and corporate profit margins,” Wagner said in a quarterly market update.
Now that the second quarter has started, a fresh wave of corporate profit and outlook statements, anticipated in the weeks ahead, will shed light on how the surging energy prices are affecting real business conditions. Early indicators point to a clear slowdown.
Supply bottlenecks to persist
On Wednesday, it was reported that Eurozone construction sector, for example, slowed down significantly in March, following a record performance in February, due to material shortages and supply delays. The S&P Global Eurozone Construction Purchasing Managers’ Index (PMI) for Germany fell to 50.9 for March from 54.9 in February. The Eurozone construction PMI was at its lowest since last October.
“After an excellent start to the year, the construction sector lost momentum in March, with the headline PMI dropping sharply from February’s two-year high and signalling a near-stalling of activity growth,” S&P Global said.
JP Morgan Asset Management, in its quarterly guide to the markets, said the sharp increase in the price of many commodities as a result of the Ukraine crisis has been further exacerbated by supply bottlenecks, which are likely to persist as China imposes lockdowns to control the spread of Covid-19.
Nevertheless, it expects equities will remain resilient to higher interest rates as long as corporate earnings continue to grow, “although value stocks are likely to benefit from persistent inflation and higher interest rates more than growth stocks.”
JP Morgan has analysed the correlation of regions and investment styles to rising 10-year Treasury yields. This analysis shows that small cap stocks, value stocks, as well as Japanese and Eurozone bonds. A similar positive correlation exists for financials, the energy sector, and industrials.
High consensus estimates in Europe
The US asset manager, which earlier this year merged its Luxembourg and Irish businesses into its German unit in order to simplify its European presence, also studied earnings-per-share (eps) expectations. That analysis showed a stark difference between expectations for projected eps growth for this year and next with the average growth between 2011 and 2019.
For the Eurozone for example, analysts expect an average eps increase of about 9 percent in 2022 and roughly 7.5 percent for 2023, compared to an average increase in eps of 2 percent per year for 2011-2019. UK companies are expected to deliver a 15 percent increase in eps for 2022, compared to an average of 1 percent for 2011-2019.
In terms of price-earnings ratios, European equities, on average, currently are priced at their historical average of 15, according to the JP Morgan report. US equities, at factor 20, are priced clearly above their historical average.
Corporate updates expected
So far there have been few formal statements from listed companies on how the sharp increase in prices for energy, commodities and throughout their markets, as well as supply chain disruptions, is affecting their earnings and their outlook. Such statements are due to materialise in the coming weeks and months when multinationals will post their first quarter earnings statements.
Related articles on Investment Officer Luxembourg:
- ‘Probability of prolonged market decline increases’
- Recession looms in Europe
- BLI’s Guy Wagner sees a second inflation wave risk