Global stocks pin hopes of year-end rally on earnings resilience

LONDON - Investors are primed for any bit of good news to help them forget a brutal quarter for stocks that took this year's value destruction to US$24 trillion (S$34.5 trillion). A resilient corporate earnings season might give them that.

The MSCI All-Country World Index just wrapped up its third straight quarter of declines, the first time that has happened since the global financial crisis in 2008. The 7 per cent drop came as investors grappled with persistently high inflation, a surging United States dollar and jumbo interest rate hikes across the world that threaten to choke economic growth.

Alongside that, analysts have slashed profit estimates, and a chorus of US and European companies - including car giant Ford Motor - has issued early warnings about third-quarter results.

But one view is that this could set firms a lower bar to clear and fuel a much-needed recovery in stocks that are currently at levels last seen nearly two years ago.

"Investors have to ask themselves how much of the bad news has already been priced in," said Mr Ron Saba, senior portfolio manager at Horizon Investments.

"Given extreme pessimism combined with reasonable valuations, the fourth quarter could give investors an opportunity to claw back some of their losses."

History is an imperfect guide, but past stock performance bodes well for the quarter. The S&P 500 gained an average of 4.1 per cent in the final quarter during the past 20 years, while the MSCI has posted a fourth-quarter decline only three times over that period.

This is not to say that companies will get through the season with glowing report cards. There is still plenty of hurdles that could cement 2022's reputation as a year to forget.

For one thing, the era of higher costs is making it difficult to defend profitability. Firms also face tighter monetary policy from the US Federal Reserve, the Bank of England and others as the central banks keep a laser focus on taming inflation. On top of that, there is the war in Ukraine, a severe energy crisis in Europe and economically damaging Covid-19 restrictions in China.

US companies with large international exposure are at risk from a stronger dollar, as underscored by Nike's disappointing earnings report on Thursday. European and British importers, on the other hand, are dealing with much weaker currencies. British conglomerate Associated British Foods and Swedish fashion retailer Hennes & Mauritz both blamed the greenback for a bleaker profit outlook.

But the scale of recent analyst downgrades, as well as the market reaction to the early announcers, suggests that "some disappointments are already expected and possibly even priced in to some extent", said Flowbank chief investment officer Esty Dwek.

A Citigroup index shows that US earnings downgrades have consistently outnumbered upgrades since early June, while global 12-month forward earnings have been revised down every month in the last quarter. Both the S&P 500 and Stoxx 600 are in bear markets - defined as a drop of 20 per cent or more from recent highs.

The big question in the lead-up to the next earnings season is whether this will be enough. Strategists at Goldman Sachs Group and BlackRock have warned that estimates are still too high and that "we are going to see pretty substantial reductions for 2023".

Yet, others see reason to believe that earnings can hold up for a while longer.

Bloomberg Intelligence (BI) analysts expect S&P 500 earnings to rise 2.9 per cent in the quarter, helped mainly by the energy sector. Ms Gina Martin Adams, BI chief equity strategist, said the absence of "economic excesses" - such as the indebtedness seen before the 2008 recession - could insulate US demand from a severe decline.

While European importers are smarting from a weaker euro, exporters are benefiting. French pharmaceutical giant Sanofi said it expects a positive currency impact of about 10 per cent in the quarter.

"Healthcare is the best sector in Europe when the dollar is rising," said Mr Manish Kabra, head of US equity strategy at Societe Generale. "A very simple trade but it always works."

Even Morgan Stanley's Mr Michael Wilson - a stalwart equity bear - said US stocks are in the "final stages" of a bear market and could stage a rally in the near term. True to form, however, he expects the sell-off to resume thereafter.

The decidedly negative investor mood could also prove to be a contrarian indicator of a short-term bounce for stocks. Sanford C. Bernstein strategists say their custom sentiment gauge has triggered a "buy" signal, meaning a "bear market rally is very possible". BLOOMBERG