Watch commodities for signals, Chinese tech selloff, Earnings Watch
By Peter Garnry, Head of Equity Strategy at Saxo Bank
The honey moon in equities since the lows in 2020 is over. Equities have gone from a regime of extreme stimulus and very loose financial conditions with profits and equity valuations exploding higher. The current regime is a minefield of downside risks with inflation hitting profit growth, geopolitical risks which could worsen the ongoing energy crisis, higher interest rates compressing equity valuations, and growing questions marks over China's economic activity this year. It all points to a defensive stance on equities and the coming months could be rough.
Equities are navigating a minefield of risks
It all started on a positive note early Monday morning following a nervous ending to last week amid escalating rhetoric in the Russia-Ukraine conflict as a potential summit between Biden and Putin had in principle been agreed to according to the White House. However, Kremlin was quickly out saying that there were no concrete plans, and now fast forward Nasdaq 100 equity futures are flirting with levels seen during the lows in January. The 13,831 level is a key level to watch on the downside and a close below today could mark the beginnings of a new leg down in US technology stocks.
Equities are generally negatively impacted from higher inflation eating into profit margins, higher interest rates impacting valuations through a higher discount rate on future cash flows, a potential war in Ukraine which could jolt energy and commodity markets around the world, and fiscal stimulus subsiding substantially this year. Following 20 months of very strong equity returns the market is beginning to reflect very different forces in our economy. Nasdaq 100 futures are down 17.2% from the highest in November and that’s even before a significant tightening of financial conditions in the US relative to the economic backdrop.
Equities were too quick this morning to buy the rumour on a summit between Biden and Putin, but the reaction was much more muted in commodities and especially the oil market. The physical commodity markets have much better information gathering on the ground and our view is that commodity markets will by far be the best signal on the geopolitical risks out of Ukraine and thus equity investors should use commodity markets as the go-to indicator to filter out the noise.
Chinese technology stocks are difficult this year
Chinese technology stocks had an ugly Friday session as new policy on Friday is aimed to curb fees of delivery companies hitting stocks of Meituan. The leading Chinese technology index, Hang Seng Tech, was trading lower again today down 49.5% from the weekly peak back in February 2021. Chinese equities have generally been hit by a slowdown in economic activity, a brewing housing crisis related to the country’s big real estate developers, and an energy crisis impacting industrial profits. But technology companies have in addition been hit by technology regulation aimed to tame the market power and anticompetitive behaviour of large technology companies. This has led to a severe growth slowdown for Chinese technology companies and the worry is that regulation of the industry is not over yet. Our view is that Chinese technology stocks might look cheap but that it is likely a trap for investors as a lot of negative sentiment could hit Chinese technology stocks until we get on the other side of the CCP Party Congress in October.
Earnings this week and the profit margin squeeze
This week will see another roughly 200 earnings releases out the 2,500 earnings releases we track during the earnings season. The US earnings season is mostly done leaving the stage for European and Chinese equities, and this week will see several important earnings releases across many different industries. We will be closely watching earnings from HSBC, Home Depot, MercadoLibre, Rio Tinto, Danone, Booking, eBay, Saint-Gobain, Alibaba, Block, Moderna, Coinbase, BASF, Amadeus IT, and Li Auto.
The most important take away from the Q4 earnings season is the contracting net profit margin which is declining for the second straight quarter in the MSCI World Index to 10.8% in Q4, which is the fourth highest reading since early 2003. We expect the net profit margin to continue to mean-revert towards the long-term mean at 7.5% suggesting a whopping 3.3%-points headwinds for global companies adding to the downward pressures in equities.
