On May 4, global shares fell steeply since the US Federal Reserve (Fed) raised interest rates by 50 basis points.
The US is now performing worse than average, with its high weighting in technology and growth stocks counting against it.
Nevertheless, a vast majority of companies have seen a positive earnings season on a whole at this juncture, with clearly demonstrated strong revenue and earnings growth, according to Frank Thormann, portfolio manager of multi regional equities at Schroders Investment Management.
“Looking ahead to the rest of the year, while earnings estimates are not being revised higher, they are also not falling dramatically, which is a fairly strong achievement,” writes Thormann.
However, there are some sectors that are more challenged with clouds gathering on the horizon. Banks, for one, saw earnings decline in 1QFY2022 largely because of a jump in provisions. Provisions are funds that are set aside in anticipation of future losses.
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“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,” says Thormann.
At the same time, Thormann posits that it is possible that many of these provisions will be relatively short lived. “The big question will be whether the US Fed can engineer a soft economic landing, or whether the economy will end up in recession,” Thormann says. “Clearly, if we end up in recession then banks could face a rise in bad debts.”
In addition, the manufacturing sector has also witnessed challenges due to inevitable cost pressure in current supply chains.
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Thormann adds that cost pressures, and the ability of companies to pass on cost increases to customers, is of significant importance these days. Making a product or service “indispensable or mission critical” is what creates the ability to raise prices without destroying demand, such that some companies are able to weather the inflationary environment better than others.
The energy sector, on the other hand, remains one of great interest, where oil prices are likely to remain relatively robust.
Thormann observes that companies in the energy sector are now exercising more capital discipline in recent times, with companies refraining from increasing drilling activity at any price.
Instead, there is increased focus on a free cash flow generation and on returning that cash to shareholders.
“That is a concept that has been pretty foreign to the energy sector in the past,” he says, which gives more reason for greater scrutiny of the aforementioned sector.
Photo: Unsplash
