As we began the third quarter, equity markets rallied into mid-August in the face of falling interest rates. This reversed as near-term sentiment turned negative. Questions percolated as to the impact on regional and global economic growth, corporate profitability, and end demand.
For the quarter, U.S. equities declined 4.5% while foreign equites fell 9.9%. Year-to-date U.S. equities have declined 24.6% while foreign equities have dropped 26.5%.
Negative sentiment has been prevalent during 2022. While it may seem as communicating the obvious, an awareness of what is driving sentiment is important.
As anticipated, monetary authorities across the globe are raising interest rates to combat inflation. As of quarter-end, the yield on the U.S. Treasury 10-Year was 3.9%. This impacts equity valuations, specifically the discounting of a company’s future cash flows and earnings, thus its price-to-earnings (P/E) ratio.
Valuations for both domestic and foreign equities have dropped from the prior year-end. The trailing 12-month P/E (P/E TTM) for the MSCI USA Index has dropped from 26.1x to 18.3x. Similarly, the P/E TTM for the MSCI All-Country World Index (ACWI) ex-USA has declined from 16.4x to 12.5x. Some may think this compression in P/E may be a revaluation in and of itself. Yet what is the expectation for corporate profitability going forward?
Front-of-mind to many is the estimation of earnings per share (EPS) and its annual rate of change versus the prior period. Currently, for domestic equities analysts are projecting EPS growth of 5.6% for calendar-year 2022, accelerating to 8.3% growth for 2023 and 8.5% growth for 2024. These are materially below what was estimated earlier this year.
Outside the U.S., analyst downward revisions have been more aggressive.
The estimated growth in EPS is somewhat muddled as analysts project a 2.3% contraction in EPS for calendar-year 2022, followed by EPS growth estimates of 3.3% and 6.9% for 2023 and 2024, respectively.
While analysts have written down their estimates for both domestic and foreign companies, the question is whether this trend in downward revisions is in the ninth inning or if we remain in the middle innings.
Opportunity in the Midst
When factoring in EPS growth, valuations may appear more opportunistic. For the next 12 months (NTM), the P/E for the MSCI USA Index stands at 15.6x which is modestly below its 20-year average of 16.0x. For the MSCI ACWI Index ex-USA, its P/E NTM is 10.8x which is materially below its 20-year average of 13.1x.
Within the U.S., analyst revisions continue to trend downward. That said, the pace of downward revisions decelerated during the third quarter. While estimated EPS growth year-over-year has been reduced from double-digit to single-digit growth, it is nonetheless positive.
We are looking through the remainder of 2022 as downside volatility appears to be priced into the near-term. Given the fluid macro-environment, the volatility in interest rates coupled with the trend in analyst revisions means we are staying the course. We believe this is best addressed by the continuous application of time-tested processes that have produced consistent risk-adjusted returns through various market cycles.
Source: BTC Capital Management, Ibbotson Associates, FactSet, Refinitiv.
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