Global Equity Weekly

May 13, 2022 | 16:30

Stocks in Distress as Asset Values Compress

Economist

Senior Economist and Director
Economics

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing regional economic, fiscal... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing regional economic, fiscal... (Read more)

Equity markets struggled again this week, with no sign of relief on the inflation or monetary policy fronts. The Nasdaq is well into bear market terrain, down almost 30% from its high at one point, the S&P 500 is flirting with that territory, down 18% before a Friday rally, while the much sturdier TSX even wandered into the correction camp, down 10.8% before a bounce to close out the week.

In the background, the Q1 earnings season is winding down, with more than 90% of the S&P 500 now reporting. The following are some metrics from the reporting period, and where it has left valuations against a backdrop of falling stock prices.

Seventy-seven per cent of the S&P 500 topped earnings expectations, according to Bloomberg’s tally, which is roughly in line with longer-term norms. Meantime, 67% topped the mark on revenues, which is a solid performance.
Overall earnings growth looks to come in at around 10% y/y, or around 4% excluding energy. Coming into the start of the earnings season in early April, consensus expectations were for 6.5% growth, so the bar has been topped.
That said, the magnitude of earnings strength and surprises is indeed fading. Growth has clearly slowed from a run rate averaging around 50% y/y through 2021 (seasonally adjusted, they might be down quarter-over-quarter as well). And, the average amount by which companies topped expectations came in at 5% in the quarter, which continues the shrinking trend of recent quarters.

Table 1 - Market Performance

Source: BMO Economics, Bloomberg

Areas of strength include consumer staples and industrials. The weak end of the spectrum saw consumer discretionary and utilities.
Earnings estimates beyond the current quarter have held up well—they haven’t increased much, but we haven’t seen large downward revisions either, yet, which is notable given how prices have come down.
Given still-sturdy earnings estimates and the sharp pullback in stock prices, valuations are in retreat. The forward price-to-earnings ratio on the S&P 500 has fallen meaningfully to around the 16.6 mark, down from just under 22 at the end of 2021. Note that the average in the three years leading into the pandemic was 17, so we’re back in the range of past norms.
However, 10-year Treasury yields averaged 2.4% in the three years pre-COVID, a good 60 bps below levels seen this week. Inflation was also much more muted. On a relative basis, the spread between the S&P 500 earnings yield and the 10-year Treasury yield remains tight (i.e., stocks relatively pricey), hasn’t moved much at all since the start of the year, and is about 50 bps tighter than the pre-COVID period. This suggests that the price decline has been largely driven by an adjustment to a higher interest rate environment, not necessarily making stocks ‘cheap’.

All told, corporate earnings have held up well so far, and the weakness in stock prices looks like a plain adjustment to a higher interest rate world. This is a takeaway that can be applied more broadly across inflated asset prices, not just stocks.

Major Index Performance

North American Sector Performances

(% change over period)

Table 2 - S&P 500 Sector Performance

Source: BMO Economics, Bloomberg

Table 3 - TSX Sector Performance

Source: BMO Economics, Bloomberg

TSX Relative Sector Performance

(relative to the index, year-ago = 100; dashed line = 200-day m.a.)

S&P 500 Relative Sector Performance