There is an old adage in investment that you should buy a share or market whose price rises on bad news. The logic is that the price action shows that the bad news was fully or over-discounted so the outlook has improved.
Storm central for the bear market in 2022 was growth, especially technology stocks and Nasdaq-listed equities. But, with Nasdaq up 16% so far this year, against less than 9% for the S&P 500, this is where the best gains have been seen.
A perfect example was provided by Meta, probably the most despised and hated “growth” stock of all.
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Meta leads growth stocks higher
Last week, it announced quarterly earnings that had halved year on year and were 22% below consensus forecasts. Yet the share price - already up over 60% from its November low - gained another 25% instantly.
The almost equally-hated Tesla, actually beat earnings estimates by 5% on turnover up 37% year-on-year (though many were expecting much worse). Its shares are up over 50% this year.
Netflix was one of the first to announce disappointing results, but it was also one of the first to take remedial action. Its fourth-quarter revenue was flat and earnings were poor. Still, the shares gained on strong subscriber growth. They have now doubled since their June low.
What about Amazon, Apple and Alphabet, whose share prices, we were told by the media, had fallen on disappointing earnings?
They did fall after earnings, but these falls need to be put into perspective - they are still up 27%, 16% and 20% respectively this year.
They’re all concentrating on lowering costs and focusing their businesses; when this comes through in better-than-expected quarterly results, the share prices could jump 10% before you can blink and 20% before you can place an order to buy.
A better-than-expected earnings performance
Ed Yardeni points out that, with 38% of the S&P 500 having reported for the fourth quarter, the earnings season is off to a poor start. Revenues have beaten reduced expectations by 1% and earnings by 2.5%. Those are the weakest metrics since 2013. Year-on-year revenues have risen 6.8% and earnings are up 4.5%. JP Morgan, with data on 45% of the S&P500, reports earnings down 5% year on year but up 4% in Europe.
What this misses is that the pessimists were expecting much worse - a dramatic collapse in earnings that sent valuation multiples sky-high with no visible prospect of recovery. That looks increasingly unlikely as economic forecasts of a severe recession turn into a mild one or just a slow-down and cost pressures abate.
It’s not just the technology sector that the bears have had their teeth into. The share prices of housebuilders and property companies have been recovering even as their business outlook deteriorates.
Even more dramatic is the turn-around in the private equity sector where high discounts to net asset value were attributed to valuers being totally out of touch with current markets.
Private equity discounts narrow as sentiment improves
3i announced a year-end valuation last week, based on strong earnings growth from its portfolio, 7% above brokers’ estimates.
This caused the share price to jump to an all-time high, 50% above last October’s low and in line with JP Morgan Cazenove’s estimate of net asset value. The market is coming down on the side of the valuers, not the Armageddon crowd.
Even more remarkable has been the response of markets to last week’s increases in interest rates; 0.25% to 4.5% in the US, 0.5% to 2.5% in the eurozone and 0.5% to 4% in the UK.
Newscasters donned their favourite masks of being the messengers of grim news for all of us but equity and bond markets jumped for joy. The yield on 10-year gilts dropped to 3% and on US Treasuries to 3.4%, indicating investors’ confidence that the average inflation rate over the next ten years will be respectively well below 3%. This in turn boosted growth equities, making future earnings more attractive, and those with good yields.
Admittedly, the fall in energy prices has raised confidence that inflation will fall and the economic downturn will be shallow, hence the Bank of England’s sharply upgraded economic forecasts but few economists took their previous gloomy forecasts seriously.
Nobody should be surprised that equity markets have started the year well and look set to
improve further. US equities rose 6.6% in January while the FTSE 100 rose 4.2%; performance in January has always been a good harbinger for the year as a whole.
Long-term US returns have been heavily concentrated in the pre-election and election years, which bodes well for 2023 and 2024.
Sentiment, as measured by surveys of both private and professional investors, was at extreme lows, suggesting it couldn’t get much or any worse. 2022 brought record outflows from retail funds in the UK of £25.7bn, far ahead of the second worst year, 2008, which saw inflows of £4.2bn. Yet the financial system was shaken to its core in 2008, making 2022’s exodus look bizarre. Retail investors have an unfortunate tendency to buy high, sell low, so act as a contrary indicator.
What could go wrong to upset the rally?
What could go wrong? Commodity prices could go back up (they are already off their lows) but if that’s due to rising demand, notably from China, rather than restricted supply, that would not be negative for markets.
The dire warnings about the health consequences of China opening up have not been fulfilled, China has surely lost interest in invading Taiwan and is focused on improving the standard of living and quality of life of its people.
Equity valuations, especially in the US, could get too high, leading to a setback in markets or consolidation as earnings catch up. This is quite normal after the initial recovery from a bear market. With valuations already optimistic, bond yields could rise, but this would slow, not reverse the recovery in equity markets.
The bulls aren’t yet roaring - which is a good sign - but the silence of the bears is deafening.
Equity markets are going higher.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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