The power of earnings growth

Chief Investment Officer's team
17 October 2021
Global stocks had their best week in 3 months, helped by a spectacular start to the Q3 earnings season


  • Global stocks had their best week in 3 months, helped by a spectacular start to the Q3 earnings season
  • Inflation is significant, but with even faster growth, stagflation fears are receding
  • Our positioning remains reasonably pro-cyclical.

With regards to top-down market drivers, last week was all about inflation and the response from central banks. There was no surprise: US CPI came out slightly higher than forecast, while the minutes from the last Fed meeting confirmed that tapering should be on autopilot. Surprises were to be found in the corporate world, and they were positive: the first releases from the Q3 earnings season were simply excellent, especially from investment banks printing record levels of activity.

As a result, stocks were sharply up and interestingly, interest rates were - modestly - lower. It’s good to remember that equities are after all nominal assets: inflation doesn’t just affect their costs but also their top-line growth, and the cyclical dynamic is currently stronger than the headwinds. EPS growth is the single most important driver for stock prices, and the welcome side effect is that fast earnings growth mechanically moderates valuation multiples.

Our outlook remains constructive, as inflation is currently a by-product of extremely strong growth alongside temporary supply bottlenecks. This should unlock the modest but positive residual upside from stocks, while interest rates should continue to gradually adjust higher. Recent economic data tend to indicate a rebound after the softness of the summer, from September PMIs to the recently released US retail sales. Our positioning remains overweight equities, with a tactical preference for DM, and underweight bonds, with a long-term preference for EM.

The week ahead will see an avalanche of earnings releases. Beyond numbers, management guidance’s will be key to assess the outlook, especially considering supply chain bottlenecks and inflation. Stay safe.

Cross-asset Update

Markets have started to discount the start of the Fed tightening cycle early in the second half of 2022, which would be basically coinciding with the projected end of the tapering of asset purchases. Yet, currently the uncertainty about actual Fed action on policy rates remains elevated and compounded by little visibility about the duration of supply-chain bottlenecks, with market valuations at the same time extremely vulnerable to tighter liquidity.

One argument runs that the Fed would not be keen to derail a stock market rally by inducing overly tight liquidity conditions with higher rates once it is done with the unwinding of asset purchases. By some time next year the global economy would have slowed further down, while inflationary pressures should have possibly faded, with supply-chain tightness and high energy prices somewhat easing and no longer exerting maximum pressure on the economy. So, Fed officials would be biding time, first assessing how the end of Quantitative Easing impacts the economy, and then pondering about future rate hikes. This would be a benign scenario where market swoons are averted in that the Federal Reserve adjusts policy in response to fading price pressures and the re-emergence of macro conditions similar to the ones predating the pandemic.

Yet, there is no assurance that price pressures related to depleted supply chains will last just enough for the Fed not to panic about higher inflation. Atlanta Fed president Bostic said that “transitory is a dirty word”, referring to inflationary pressures, and that “upside risks to the inflation outlook bear watching closely”. In addition, according to the FOMC minutes risks worsened, letting transpire Fed officials’ concerns about longer run expectations shifting higher and leading to “persistently elevated inflation”. Also, the Fed has boxed itself into a very uncomfortable corner, by keeping liquidity going as much as it could in spite of improving economic conditions, so getting exposed to the risk of falling behind the curve in terms of inflation management. So far, markets have given Jay Powell the benefit of the doubt about inflation not getting out of hand, since both longer-dated Treasury yields and market-implied inflation gauges are bell-behaved in spite of price spikes and much hesitation about starting the tapering. Should the Fed’s credibility take a hit, a disorderly rise in yields could hardly be averted.

For now, liftoff time is still way away and investors can wield patience about supply-chain related inflation, believing it is sufficiently transitory as to be properly managed by the Fed. So, markets are likely to continue to rally into year-end, with equities grabbing the lion’s share amidst overly plentiful liquidity and credit playing only second fiddle. The dollar should remain well supported as the US leads a rebound in economic surprises, and gold no longer so weak with the announcement of the tapering in November now a formality.

But the longer the system is unable to get rid of ‘transitory’ inflation, the more unstable today’s hunky-dory market conditions will become.

Fixed Income Update

There are three key takeaways from last week’s release of September FOMC meetings. Firstly, there should be no surprise in the timing and size of the Fed taper, which is expected to start later this year and finish by mid-next year. Secondly, there is a lot of anxiety about the level of inflation and its stickiness. Lastly, the members would like to see more improvement in the jobs market before the final lift-off happens, and hence employment numbers are the key to gauge the timing of the rate increase. Last week there was a flattening of the US Treasury yield curve with front-end rates rising and long-end coming down on the backdrop of the aggressive Fed tightening path post the taper regime next year. We remain bearish on the long end of the curve since we believe the market pricing of the terminal rate remains well below the Fed’s long-run target of 2.5%. At the same time, we do not think a significant sell-off of the 10-year is possible from current levels due to softening growth levels. We believe in a more modest upward repricing as we progress to the end of the year.

The twist in the treasury yield curve resulted in various segments of the asset class finally returning in the green after weeks of negative returns. Long duration assets such as Emerging Market Sovereigns and Investment Grade debt were the primary beneficiaries of such a move returning more than +0.5% last week.

Asia High Yield remains under pressure as the market is still coming to terms with the elevated default levels. According to analysts, total default rates could reach 20% by volume for the China HY real estate sector, the majority of which would be from the Evergrande’s bond complex. Our calculations indicate the market is pricing in a pessimistic 35% default rate over the long-term average for the segment. Evergrande would finish its 30-day grace period for the first dollar bond next week on Oct 22. Investors do not expect interest payment despite the authorities’ directive not to default on the offshore obligations in the short term. Further downside to the asset class would stem from unexpected corners of credit risk such as the Fantasia case rather than evolving news on Evergrande. We continue to like the bonds complexes of the Investment Grade Chinese Real Estate Companies on our recommended list. But would remain cautious on the beta from the segment, and selectivity remains critical.

Closer home, Oman was a firm outperformer this week with sufficient demand for the credit from US RM, especially after Moody’s upgrade of the credit from Negative to Stable outlook with bonds +2.25pts higher on the week. We had mentioned our preference for the Oman sovereign/quasi-sovereign bonds in our last weekly publications. After several months of underperformance Egypt seems to have turned a corner last week as bonds are up by +1 pt. On the contrary, the MENA IG bonds have remained weak in the belly and long-end as spreads widened by +7 bps.

Equity Update

A good week for equities with both Emerging and Developed Market up 2.1% and our overweight positioning has been vindicated, after a September which saw global equities down over 4%. Good performance from U.S. equities last week, the S&P 500 gained 1.8%, and the Nasdaq 2.2%, with upbeat earnings and economic data that eased concerns about a slowdown in growth, amid an elevated inflationary environment. September retail sales activity came in stronger, import prices lower than estimated. European markets gained in line with the U.S. with Energy and Financials notable contributors, the former as oil prices resumed their rally and the latter in line with the spectacular US bank earnings.

EM equities ended the week with gains from the UAE, India and MSCI China with the Hang Seng Index the outperformer at +5% as China authorities provided assurance on real estate credit issues, mitigating immediate investor concerns. However, we remain neutral EM Asia/ China as profitability of many sectors have been affected by the new China regulation oversight. Social media has been one of the key targets with regulators worrying about data on China residents being monopolised by a few corporations. LinkedIn is shutting down its social networking site in China, the last major US social media company to exit after “facing a significantly more challenging operating environment and greater compliance requirements in China”

We are currently overweight equities and our stronger preference for DM equities continues with the earning premium provided by the US and Europe in 2021. However, we would watch closely rising commodity prices, supply chain constraints and inflation data. And of course, the path of monetary tightening. The U.S. Dept. of Energy estimates that heating costs for households will be 30% higher this winter, Chinese coal futures had their biggest weekly rise on record, Europe continues to be impacted by rising natural gas prices and in UK fuel shortages continue. Supply chain limitations are increasing with the US facing a shortage of warehouse space and truck drivers, congestion at the LA/ Long Beach port (40% of goods imported into the US), Salesforce estimates logistics, labour and manufacturing problems combined could add $223bn to US retailers’ costs this holiday season, Germany is seeing a shortage of chips essential for EV batteries.

Consensus expectations for Q3 earnings growth for the S&P 500 is 28%, the third highest y/y growth since 2010, but guidance remains key, as well as the impact of rising input costs. Bank earnings saw strong growth in investment banking revenues as M&A and IPO activity has been robust, as has trading revenues in the equity markets, with strong, asset inflows continuing, while loan loss reserves were released. The one relatively soft spot remains net interest income as loan growth continues to be outpaced by deposit growth. Whilst Q3 EPS was up over 20% for the main US banks, Goldman’s CEO put out a note of caution, pointing to the trajectory of inflation, the Delta variant of Covid-19, the debate around US economic policy and “complicated” US-China relations as risks. For the European Stoxx 600 consensus earnings expectations for the third quarter are 60% y/y growth.

Written by:
Emirates NBD Bank PJSC (“Emirates NBD”) is licensed and regulated by the UAE Central Bank and this website aims at providing Internet users with information concerning Emirates NBD Private Banking, its products and activities. Persons having access to information made available by Emirates NBD on this website accept the following rules:

Emirates NBD uses reasonable efforts to obtain information from sources which it believes to be reliable, however Emirates NBD makes no representation that the information or opinions contained in publications on this website are accurate, reliable or complete. Published information may include data/information from stock exchanges and other sources from around the world and Emirates NBD does not guarantee the sequence, accuracy, completeness, or timeliness of information contained on this website provided thereto by unaffiliated third parties. Anyone proposing to rely on or use the information contained on this website should independently verify and check the accuracy, completeness, reliability and suitability of the information and should obtain independent and specific advice from appropriate professionals or experts. Further, references to any financial instrument or investment product are not intended to imply that an actual trading market exists for such instrument or product. Emirates NBD is not acting in the capacity of a fiduciary or financial advisor. Any publications on this website are provided for informational purposes only and are not intended for trading purposes. Data/information provided herein is intended to serve for illustrative purposes and is not designed to initiate or conclude any transaction. The information available on this website is not intended for use by, or distribution to, any person or entity in any jurisdiction or country where such use or distribution would be contrary to law or regulation. This website and anything contained herein, is provided "as is" and "as available," and that Emirates NBD makes no warranty of any kind, express or implied, as to this website, including, but not limited to, merchantability, non-infringement, title, or fitness for a particular purpose or use.

The provision of certain data/information on this website is subject to the terms and conditions of other agreements to which Emirates NBD is a party. Emirates NBD reserves the right to make changes and additions to the information provided at any time without prior notice. The information may be modified or removed without prior notice. No buy or sell orders submitted via the internet or email will be accepted. In addition, the data/information contained on this website is prepared as of a particular date and time and will not reflect subsequent changes in the market or changes in any other factors relevant to the determination of whether a particular investment activity is advisable.

Information contained on this website is believed by Emirates NBD to be accurate and true, in all material respects. Emirates NBD accepts no responsibility whatsoever for any loss or damage caused by any act or omission taken as a result of the information contained on this website. Further Emirates NBD accepts no liability for the information and opinions published on the website and is under no obligation to remove outdated information from its website or to mark it clearly as such. The information given on this website may not be distributed or forwarded in whole or in part. Accordingly, anything to the contrary herein set forth notwithstanding, Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries shall not, directly or indirectly, be liable, in any way, to you or any other person for any: (a) inaccuracies or errors in or omissions from the information available on this website including, but not limited to, quotes and financial data; or (b) loss or damage arising from the use of this publication, including, but not limited to any investment decision occasioned thereby. or (c) under no circumstances, including but not limited to negligence, shall Emirates NBD, its suppliers, agents, directors, officers, employees, representatives, successors, assigns, affiliates or subsidiaries be liable to you for direct, indirect, incidental, consequential, special, punitive, or exemplary damages even if Emirates NBD has been advised specifically of the possibility of such damages, arising from the use of the information on this website, including but not limited to, loss of revenue, opportunity, or anticipated profits or lost business. Emirates NBD expressly accepts no liability for losses or damages of any kind arising from using or accessing this website or links to third-party websites or from viewing information on any of its web pages. Furthermore, Emirates NBD accepts no liability for any unauthorized manipulation of users IT systems. Emirates NBD expressly draws user’s attention to the risk of viruses and the threat of hacker attacks

Third Party Website:
Users may be aware that Emirates NBD has no control whatsoever over third-party websites linked to or from this website and therefore accepts no liability for the content of such websites being correct, complete and legally valid for the products and services offered on such websites. Emirates NBD’s express written permission must always be sought before including a link to this website on a third-party website.

None of the information on this website in any way constitutes a solicitation, offer, opinion, or recommendation by Emirates NBD to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any security or investment.

Forward Looking:
The information contained on this website does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. Certain matters in this publication on the website are about the future performance of Emirates NBD or members of its group (the Group), including without limitation, future revenues, earnings, strategies, prospects and all other statements that are not purely historical, constitute “forward-looking statements”. Such forward-looking statements are based on current expectations or beliefs, as well as assumptions about future events, made from information currently available. Forward-looking statements often use words such as “anticipate”, “target”, “expect”, “estimate”, “intend”, “plan”, “goal”, “seek”, “believe”, “will”, “may”, “should”, “would”, “could” or other words of similar meaning. Undue reliance should not be placed on any such statements in making an investment decision, as forward-looking statements, by their nature, are subject to known and unknown risks and uncertainties that could cause actual results, as well as the Group’s plans and objectives, to differ materially from those expressed or implied in the forward-looking statements. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.

Risk: In addition, before entering into any transaction, the risks should be fully understood and a determination made as to whether a transaction is appropriate given the person’s investment objectives, financial and operational resources, experiences and other relevant circumstances. The obligations relating to a particular transaction (and contractual relationship) including, without limitation, the nature and extent of their exposure to risk should be known as well as any regulatory requirements and restrictions applicable thereto. Data included on this website may rely on models that do not reflect or take into account all potentially significant factors such as market risk, liquidity risk, and credit risk. Emirates NBD may use different models, make valuation adjustments, or use different methodologies when determining prices at which Emirates NBD is willing to trade financial instruments and/or when valuing its own inventory positions for its books and records.

Investment in financial instruments involves risks and returns may vary. Before making such an investment, investors should consult their advisers on the legal, regulatory, tax, business, investment, financial and accounting implications of the investment.

Intellectual property:
The information on this website has been developed, compiled, prepared, revised, selected, and arranged by Emirates NBD and others (including certain other information sources) through the application of methods and standards of judgment developed and applied through the expenditure of substantial time, effort, and money and constitutes valuable intellectual property of Emirates NBD and all present and future rights in and to trade secrets, patents, copyrights, trademarks, service marks, know-how, and other proprietary rights of any type under the laws of any governmental authority, domestic or foreign, shall at all times be and remain the sole and exclusive property of Emirates NBD and/or other lawful parties and you acknowledge that you have no ownership rights in and to any of such items. Except as specifically permitted in writing, the information provided in this website shall not be copied or make any use of any information on this website or any portion of the intellectual property rights connected with this website, or the names of any individual participant in, or contributor to, the content of this website, or any variations or derivatives thereof, for any purpose. Further you shall not use any of the trademarks, trade names, service marks, copyrights, or logos of Emirates NBD or its subsidiaries in any manner which creates the impression that such items belong to or are associated with you or, except as otherwise provided with Emirates NBD’s prior written consent,

The information on this website solely for non-commercial use and benefit and the use of this information is not intended for resale or other transfer or disposition to, or use by or for the benefit of, any other person or entity. Information contained in this website shall not be used, transferred, distributed, reproduced, published, displayed, modified, create derivative works from any data contained on this website or disposed of in any manner that could compete with the business interests of Emirates NBD. Any part of this website may not be offered for sale or distribute it over any medium including but not limited to over-the-air television or radio broadcast, a computer network or hyperlink framing on the internet without the prior written consent of Emirates NBD. The information contained on this website may not be used to construct a database of any kind. The data on this website shall not be used in any way to improve the quality of any data sold or contributed by you to any third party.

Recipient Acknowledgements
In accessing this website, you acknowledge and agree that there are risks associated with investment activities. Moreover, you agree that your use of this publication is at your sole risk and acknowledge that the responsibility to obtain and carefully read and understand the content of documents relating to any investment activity described on this website and to seek separate, independent financial advice if required to assess whether a particular investment activity described herein is suitable, lies exclusively with you.

Emirates NBD Bank (P.J.S.C.) is licensed by the Securities & Commodities Authority and subject to regulation, supervision and control of the Authority.
Head Office : Baniyas Road, Deira, PO Box 777, Dubai, UAE