Why equity investors are looking beyond the current earnings recession to a gradual economic recovery.
Current thoughts on the market
There are a few things worth highlighting about the markets at the moment:
- Unemployment rates are skyrocketing, and labour market has deteriorated significantly and very rapidly. We need to therefore watch the potential negative feedback loop on the economic activity of such deterioration, if we don’t get back to previous levels of employment once economies come out of lock-down fully. That risk is significant in our view, given that the shape of both supply and demand is unlikely to come back to normal post lockdowns as a result of enforced social distancing.
- Economic leading indicators are likely to rebound over the next 1-3 months in our view. It is somewhat mechanical, given how sharp a deterioration we have seen as lockdowns got implemented across the globe and given the fact that the survey is assessing improvement/deterioration compared to the previously carried survey. It might have the potential of sending the market into hope or euphoria about a rapid recovery in economic activity coming up. But that recovery could be more muted than what the PMI headline figures might imply.
- The shape of recovery will still be an important talking point for the months and years to come, so we will need to remain vigilant as the situation evolves, and continue to reassess our core assumptions. As a reminder, we have a core top-down assumption of a recovery that is likely to be gradual, without going back to previous levels of activity until 2022.
Corporate earnings results
It has been a very busy results season given the significant recessionary environment we are going through as a result of the pandemic crisis. It has certainly been the busiest results season in my close to 23 years of experience of financial markets.
- Earnings downgrades have been significant since the start of the year - to the tune of 25%+ downgrades with earnings declines now standing at more than 20% year on year for the US and Europe, and close to -20% for MSCI World1. Earnings seasons have shown confirmation of the magnitude of slow down, and we are forecasting Q2 to show an even more severe slow down. Earnings surprises for Q1 have been negative, despite the sizeably reduced estimates ahead of reporting, with a 1% negative surprise in the US and a 3% negative surprise in Europe2.
- We continue to see our core scenario for 2020 as accurate based on what we have seen from this results season. Our core assumptions are implying a year-on-year earnings decline of circa 33% globally in 2020, so we are still expecting more earnings downgrades to come3.
- The market reaction to the earnings has clearly been positive, with a shift from the fear we saw in March, to a willingness to look through to recovery rather than to the current profit warnings and downgrades that we are going through.
Believing in an investment opportunity comes from having conviction about the investment case.
At Martin Currie, we manage high conviction strategies focusing on long-term sustainable quality growth stocks which have low disruption risk, high barriers to entry, strong pricing power, attractive growth and returns profiles, good ESG profile and attractive valuations.
Our focus is on best ideas, delivered in a high conviction way. We estimate conviction levels on any stock we hold through our proprietary analytical framework and seek to ensure that all of our holdings express our strong convictions on business model, competitive positioning, structural growth outlook, returns profile and potential for further improvements. In addition, we rapidly act and attend urgently to stocks where our conviction is weakening, in order to understand the reasons for that, and assess how we can rebuild conviction
Also, focusing on delivering solely high-conviction stocks means that we have to make tough choices. We generally assess upside to price target, conviction levels, risk profiles and impact any of these stocks have on the overall risk exposures and shape. It ensures that we stay disciplined and only buy new stocks based on a high threshold of selection criteria.
1 Source: Bloomberg consensus estimates, 2020 and J.P. Morgan estimates, 2020.
2 Source: J.P. Morgan, Q1 Earnings Season Tracker – Key Takeaways, 2020.
3 Source: Bloomberg consensus estimates, 2020 and J.P. Morgan estimates, 2020.
Environmental, Social, and Governance (ESG) refers to the three central factors in measuring the sustainability and societal impact of an investment in a company or business.
Leading Economic Indicators (LEI) are measurable economic factors that change before the economy starts to follow a particular pattern or trend. While they are used to predict changes in the economy, they are not always accurate.
The MSCI World Index captures large and mid-cap representation across 23 Developed Markets (DM) countries
A pandemic is the worldwide spread of a new disease.
Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.