The End of Earnings Growth?
The third quarter earnings reporting season starts this week with quarterly results from companies across different industries and countries including Delta Air Lines, Fast Retailing, PepsiCo, Taiwan Semiconductor Manufacturing Company, JPMorgan Chase & Co., and Citigroup, among many others. Solid earnings growth had been a bright spot in the first half of the year amid weakening economic growth, but the third quarter saw slowing sales, excess inventories and higher costs that are likely to have had a negative impact on results and forward-looking guidance from corporate leaders.
Dimming global earnings outlook
The outlook for earnings is dimming on the cusp of the reporting season. Historically, there is a tight relationship between the global manufacturing purchasing managers' index (PMI) and earnings growth for global companies, as you can see in the chart below. The PMI tends to lead the trend in earnings growth by three months, with the dividing line at 50 between expansion and contraction in global manufacturing aligning with the analysts' consensus outlook for earnings growth and contraction over the coming year. The PMI turned negative in September as the quarter came to an end, likely pointing to flat earnings on a year-over-year basis for global companies as we look out to the fourth quarter.
Indicator points to the end of earnings growth
Source: Charles Schwab, Macrobond MSCI, S&P Global data as of 10/9/2022.
While analysts' estimates have been declining, they are still clinging to an outlook for mid-single-digit earnings growth in 2023 for the companies that make up the MSCI World Index and for companies in most major countries and regions including those in the MSCI indexes for the United States, Europe, Japan, and Canada. Yet, leading components of the PMI, such as new orders, suggest a further economic slowdown in the months ahead and a coming decline in earnings. If so, the erosion of earnings as a key support for stocks could lead to a further stock market sell-off in the weeks ahead as corporate leaders guide analysts to further lower their earnings estimates.
Exception to the trend
There is a surprising exception to this global downtrend in earnings: the United Kingdom. Earnings estimates for U.K. companies have continued to move higher in the second half of this year—especially compared to the S&P 500 Index, as you can see in the chart below. The analysts' consensus S&P 500 earnings per share estimate for 2022, at about $224, has been declining since June. But earnings for U.K. companies have continued to climb to over £230 from £170 at the start of the year. This has helped the stocks in the MSCI United Kingdom Index to outperform the S&P 500 this year by 23 percentage points in local currency and five percentage points when measured in U.S. dollars.
2022 earnings per share consensus analysts' estimates
MSCI United Kingdom Index earnings per share consensus analysts' estimate for 2022 in British pounds, S&P 500 Index earnings per share consensus analysts' estimate for 2022 in U.S. dollars. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.
Source: Charles Schwab, FactSet data as of 10/9/2022.
A reason for U.K. earnings strength is the pound's 18% plunge relative to the U.S. dollar this year. Historically, earnings for U.K. companies tend to benefit from a weak pound. Currently, for the companies in the MSCI United Kingdom Index, 27% of revenues are in dollars—the largest share—and greater than the 19% of sales that are in pounds. With most costs in pounds, the result is that U.K. businesses are seeing a positive currency contribution to their earnings growth.
Revenue exposure by country/region for U.K. companies
Based on companies in MSCI United Kingdom Index. Showing top 8 of 257 countries. Values based on FactSet's proprietary algorithm.
Source: Charles Schwab, FactSet data as of 10/9/2022.
After the new U.K. government's decision in September to aggressively ease fiscal policy while inflation is very high, markets responded with a rapid drop in the pound and rise in U.K. government bond yields. This prompted the Bank of England (BoE) to intervene in the U.K. government bond market by temporarily buying long-dated gilts "to restore orderly market conditions." It also delayed plans to start quantitative tightening (QT). The BoE was expected to close its window for emergency bond-buying on Friday but has now decided to remain available to act if conditions warrant until November 10. The BoE's measures have calmed the sharp sell-off in the U.K. bond market; it is not clear if the U.K. bond market can keep calm without the support of the BoE. The fall in the pound remains a cloud over the U.K. economy as it boosts the prices for imports, worsening inflation pressures. The U.K. is facing higher interest rates to suppress inflation which may weigh on domestic demand and worsen the outlook for U.K. revenue.
While analysts' earnings outlook for U.K. companies and the U.K. stock market remains outperformers this year—even after the recent turmoil—there are risks to U.K. leadership. We will be watching to see if markets remain calm as BoE support fades and if the reports by U.K. companies in the weeks ahead continue to support a rising trend in earnings as the global earnings outlook dims.