What Have You Done for me Lately?

by | January 31, 2022

Back in 1986, Janet Jackson admonished her former fun-loving partner, who now lounges on the couch, by asking ‘What have you done for me lately?’

Investors could be forgiven if they asked the same of corporate earnings. Stellar profits sent share prices soaring in 2021. Not anymore.

The fourth quarter earnings season is well underway, with over a third of S&P500 firms having reported year-end 2021 profits. Objectively, the numbers are good. According to FactSet, year-on-year earnings growth in the final three months of 2021 could reach 24%. Over three-quarters of companies are beating earnings growth estimates and even more are topping revenue estimates.

And yet the market has crumbled at the start of 2022. Major global indices are down anywhere from 4% to 12% in the month of January. In the S&P500, all sectors are in negative territory year-to-date, except energy, which has soared based on surging oil and gasoline prices. Those gains, however, are hardly healthy, as they largely reflect concerns about geopolitical risk amid tight inventories. That’s not the stuff to dance about.

Of course, it is better to have some earnings rather than none. Listed companies that don’t make money are getting slammed hardest. Initial public offerings (IPOs) are down 20% at the start of the year. Small capitalization growth stocks, which often report few or no profits, are down 11%. And information technology shares are down 9%. Strip out the biggest names with the highest profits, and the tech sector has cratered. Just ask Cathie Wood, whose ARK Innovation ETF has dropped 58% from its peak.

Does all that mean that investors should now dump their unreliable earnings partner? Probably not. Short of a recession, earnings growth will likely remain positive this year. And, as noted, not having any earnings is even worse.

But the markets are nevertheless sending a clear message—the days when investors could count on rising profits to deliver higher share prices have come to an end. Partly, that is because profits growth is slowing for virtually all companies and sectors. According to FactSet, the consensus of stock market analysts forecasts that S&P500 earnings growth will slow to about 5% in the first half of 2022. Double digit growth is a thing of the past.

As we have pointed about before, slowing earnings growth means that equity market returns will be lower and episodes of volatility more frequent. Risk-adjusted returns, in other words, have begun to fall, as ought to be the case at this point in the earnings cycle.

But slowing profits growth also means that other factors—above all economic growth, inflation, and policy responses—become more important for investor psychology.

This week, corporate profits will move to the background given an avalanche of key global economic data. The next five days are crowded with inflation, purchasing manager, and labor market data from all major economies. 

Japan reports consumer confidence and unemployment data early in the week. Germany offers inflation and purchasing manager readings. In the US, the twin reports from the Institute of Supply Management on manufacturing and services are due, as are statistics on job openings and quits. The week finishes with the all-important US employment report.

When judging the importance of incoming economic data for financial markets, it is useful to first consider what the consensus expects. Based on market pricing, particularly in US short- and medium-term Treasury securities, the consensus has firmly adopted the view that strong growth and high inflation warrant roughly four quarter-point interest rate hikes in 2022. Various Fed officials have passed on opportunities to disagree, lending credence to market expectations. 

Among professional forecasters, meanwhile, various banks, investment banks and asset managers have been falling over themselves to see who can offer the most hawkish Fed scenario. Some pundits have penciled in 7 quarter point Fed hikes this year, namely one quarter-point tightening per Fed meeting starting in March. We are not aware of any major financial institution that believes the Fed will hike less than three times this year.

Accordingly, this week’s data will be fascinating to watch. Aggressive rate hike expectations, after all, need affirmation or else they, like earnings, could jilt their lovers.

With that in mind, consider the following. Japanese consumer confidence, due out on Monday, is expected to remain subdued, some five points below its pre-pandemic highs. If that sounds familiar, it is. The same is true in the US. High inflation and Covid uncertainty are weighing on consumers globally. December saw a sharp deceleration in US household spending. Personal savings rates, which initially fell sharply from pandemic peaks, have recently edged back up. Fiscal support measures are being withdrawn. Non-eviction stopgap measures may go next. Wobbly equity markets may unnerve consumers as well. If final demand decelerates, can aggressive tightening expectations hold up?

Also, inflation may be peaking. In Germany, harmonized inflation is expected to dip from its recent high of 5.7%. Last month, the US ISM prices paid index dipped. If it does so again this week, that might herald a lessening of pipeline goods price pressures. Already, anecdotal evidence points to lessening shipping delays. Those developments could be important, insofar as goods prices have led the surge in overall reported inflation during 2021. 

Meanwhile, in Friday’s employment report, year-on-year wage inflation is expected to jump to over 5%, which will hog the headlines. But monthly wage increases are forecast to slow a bit from their December pace. And less noticed has been an upward creep in the labor force participation rate, which has been edging higher since mid-2021 and could top 62% in Friday’s report. While that level would still be 1.4 percentage points below its pre-pandemic peak, it might nevertheless trigger a re-think about US labor supply flexibility, trend growth, and wage-related inflation risk.

As January ends, we are entering a precarious position for investors. Slowing earnings growth and some adjustment of global monetary policies this year have fundamentally changed risk and return dynamics. Investors are correct to adjust their expectations and, in some cases, their portfolios. 

But there is a second risk—overreacting. In markets, it pays to be contrarian. Investors who have simply extrapolated earnings growth or who jumped on bandwagons of theme stocks have been rudely reminded this year of the dangers of running with the crowd. Meanwhile, the crowd has moved on. It is now supremely confident that Fed policy must be tightened aggressively. But that is now in the price. If bonds and stocks are to fall further on Fed fears the data must continuously reinforce expectations of strong growth, sluggish supply responses, and high inflation. The bar on bearishness is high and rising.

All too often, consensus positioning is like Janet Jackson’s lover—lots of fun in the beginning, the life of the party, and even intoxicating. But as Janet reminds us, it is good to be aware. At some point, the consensus can turn into a burden, becoming a loathsome couch potato.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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