Weekly Investment Commentary: Yearning for earnings growth
Bottom line up top:
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Stock market bears have something in common with bears in the wild emerging from hibernation: Both are “hangry” and prowling for sustenance. This makes it a good time for us to update our Nuveen Bear Market Tracker (Figure 1). We introduced the tracker last year to help inform discussion and debate around U.S. bear market dynamics, with a focus on valuations, earnings, U.S. Federal Reserve policy, manufacturing activity, market breadth and bond spreads. These metrics are currently a mixed bag, but they suggest that the market’s bad news bears are still being fed a data diet sufficient to prolong their existence. More broadly, a host of economic data — including JOLTS, ADP private payrolls, and service and manufacturing PMIs — have come in softer than expected, increasing the odds of at least a mild recession.
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Is the Fed “earning” a recession? Although the unofficial start to corporate earnings season isn’t until this coming Friday, earnings growth expectations for the S&P 500 Index have fallen precipitously since the beginning of the year (Figure 2). Current estimates point to a sharp contraction (-7.0%) year-over-year for the first quarter, and growth of only 0.94% for calendar year 2023. Barring an upside surprise, this would mark the second consecutive quarter of negative earnings growth (-5.8% in 4Q 2022), putting the S&P 500 in an earnings recession. Earnings recessions historically haven’t guaranteed a broader economic downturn will follow, but we expect the factors that have driven earnings degradation (inflation and the Fed’s historic reaction to it) will indeed lead the U.S. economy to contract. With that in mind, our Portfolio Considerations section examines the areas of equity markets investors might seek out, and which to avoid.
“Earnings growth expectations for the S&P 500 Index have fallen precipitously since the beginning of the year.”
“Certain equity sectors that were among the hardest hit by rising rates over the past year maynow be poised to benefit.”
Portfolio considerations
With the end of the interest rate hiking cycle approaching, certain equity sectors that were among the hardest hit by rising rates over the past year may now be poised to benefit. Within information technology, we believe software could get a big boost. Select software companies that are less cyclical in nature may be good candidates for defensive positioning as we face an economic slowdown and possible recession later this year. Software names tend to have more resilient business models and inelastic demand, with cash flows driven by enterprise revenue — typically a more consistent source of recurring revenues than consumer-focused companies. They’re also more adaptable to changes in the economic environment, with the ability cut costs without curtailing their business.
Consumer discretionary exposure tilted toward global consumers is another area we find attractive. U.S. consumers face near-term challenges, as the unemployment rate is likely to rise, while savings are depleted to meet higher expenses amid persistent inflation. Specifically, consumer exposure favors countries and regions like China, where we see positive catalysts in the form of government stimulus, pent-up demand from Covid lockdowns and strong employment markets.
We are less optimistic about financials and public real estate, two sectors with decreasing 2023 earnings growth estimates since the start of the year (Figure 2). Banks will be facing regulatory pressures on capital liquidity, as well as increased competition for customer deposits. Additionally, bank lending standards have tightened and will likely continue to do so, with potentially negative implications for the wider economy. Regional bank concerns in the wake of the Silicon Valley and Signature closures could flow into the real estate market, as such banks have significant exposure to commercial real estate. We are cautious about the office and retail property subsectors, both of which are more cyclical. In particular, office is still feeling the pinch from the work-at-home environment, with many tenants opting to shrink their physical footprint.
“U.S. consumers face near-term challenges, as the unemployment rate is likely to rise while savings are depleted.”
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
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macro and asset class views that gain consensus among our investors
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insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
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guidance on how to turn our insights into action via regular commentary and communications
Endnotes
Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
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