Why Earnings Season Couldn’t Save the Stock Market This Time
May 10, 2022
Although first-quarter results have been largely positive, investors have found little solace this earnings season.
According to Credit Suisse statistics, the S&P 500 profits per share are on track for an 11 percent year-over-year gain on a 13.5 percent increase in sales. Nonetheless, the index has fallen 10% since the results began to come in early last month. The Nasdaq Composite has dropped over 20% in a month. What's going on?
Simply said, investors these days are more interested in the macro than the micro.
It all comes back to the Federal Reserve and tightening monetary policy, plus a few additional wild cards that just add to the uncertainty and volatility, such as the war in Ukraine and all of its awful consequences. This has resulted in decreased stock and bond prices, which move inversely to yields.
Overall, stock price-to-earnings multiples have fallen faster than profits. The macro pressure has been especially intense in growth-oriented segments of the market, while the micro hasn't always been particularly supportive. Since the start of the first-quarter results season, the Vanguard S&P 500 Value exchange-traded fund VOOV has lost around 7%, compared to an 18% decline for the Vanguard S&P 500 Growth ETF VOOG.
For the last two years, the Fed has kept interest rates at zero while purchasing tens of billions of dollars in bonds and other assets each month, a policy known as quantitative easing. Now that interest rates are rising, the Fed will begin to let its balance sheet decrease as its holdings mature.
Bond and interest rate futures markets have risen in expectation of more increases. According to CME Group statistics, current pricing predicts another two percentage point increase by the Fed through the end of this year, on top of the three-quarters of a percentage point increase at the last two meetings.
Greater benchmark interest rates and bond yields represent a higher cost of capital for enterprises that rely on financing, whether through bond issuance, bank borrowing, or venture capital. Companies that are expected to generate the majority of their revenues in the distant future are worth less now when those earnings are discounted back to the present using a greater discount rate.
Cash is practically worth more now, favoring more established, profit-generating enterprises over startups and more early-stage growth organizations. As a result, the changing monetary policy environment has had the greatest impact on growth stock valuations in sectors such as technology, software, consumer discretionary, and biotech. Overall, the S&P 500 value stocks are trading at around 15 times their forecast earnings over the next 12 months and have decreased by over 17 times in early 2022. Meanwhile, the S&P 500 growth stocks' future price-to-earnings ratio has fallen to under 21 times from about 28 times since the beginning of the year. For the S&P 500 as a whole, that multiple has dropped to 17 times from around 21.5 times.
That is the macro pressure on market multiples that has overshadowed first-quarter sales and earnings increases in the S&P 500's energy, materials, and industrial sectors.
This earnings season, the micro hasn't been kind to growth stocks. According to Credit Suisse, S&P 500 value stocks have recorded year-over-year profits and sales growth of 14.0 percent and 13.7 percent, respectively, against 9.3 percent and 13.1 percent for growth. Do cheaper value stocks generate faster profit and sales growth than highly valued growth firms? This is not what investors have been accustomed to.
Some of the growth disappointment may have been predicted. The pandemic's first two years were ideal for numerous growing firms, like e-commerce, streaming, and remote working. As the influence of Covid-19 on daily life fades, some of those consumption patterns will revert or, at the very least, will not continue to accelerate indefinitely.
Many growth companies' first-quarter earnings have reflected this hangover: Netflix (NFLX) saw a drop in subscribers, Teladoc Health (TDOC) wrote down the value of its business, and online retailers like eBay (EBAY) and Etsy (ETSY) have taken a hit for their gloomy 2022 financial forecasts despite solid first-quarter numbers, to name a few.
When you combine the Fed's tightening of the noose with high-profile failures from growth stocks, you have a sliding market despite excellent results.