The next risk: Financial results

So far, we have witnessed a good part of the year with a correction of the financial markets at the global level because of the rise in interest rates. We can say that it was mainly a bond bear market for the first 6 months. It’s time to ask what the next risk in financial markets would be, such as the impact of interest rates on financial results.

What are financial results?

The stock markets are a set of companies that are listed on the stock exchange. As these companies go public, they are required to disclose information, including financial results.

Simply put, it is the revenue and profit/loss that a business will generate over the course of the year or a quarter. This is also why we say that the stock markets are leading indicators of the economy, since they represent several sectors within the economy.

At the quarterly level, the 4 major earnings seasons are in January, April, July and October in the US. When an investor goes to study the figures of a company, he will be interested in the financial health of the company. More specifically, it is the study of figures within the company such as the income statement (profit/loss), the balance sheet (assets/liabilities), or other statements… Generally, this kind of practice is known as that of “bottom-up”. It consists of finding securities that are trading on the stock exchange below their real value.

The importance of understanding financial results

Beyond the global macroeconomic context which will also have an impact on companies, it is important to understand the figures within the company. The figures reflect the health of these since this is also how an investor will gain confidence in the future of the company.

When a company is going to make money, it will reinvest its profits in two ways:

  • reinvest in society for research and development;
  • redistribute in the form of dividends;
  • or repurchase the company’s own shares in order to decrease the bid and increase the share price.

Generally, it is the financial results that bring investors into or out of the financial markets. The more confidence there is in the markets, the more flows will enter and vice versa.

Here is a nice graph that plots inflows and outflows against the progress of the results (earnings) at the level of global markets.

financial results
Source: Twitter

The place of financial results in the phase of the economic cycle

Generally, the first factor of the economic cycle is the slowdown in the real estate market, and secondly, we have “new orders” which will slow down. The new orders are used to measure the future demand needed to produce the goods and services. When demand for new orders slows down, this is a first sign that production at the enterprise level will also slow down.

This is why the phase of the slowdown in profits (financial results) is after that of new orders.

Here is an illustration of new orders vs. financial results. There is a positive correlation between the two. However, there is a difference between the two.

Source : Twitter

The PIC of financial results

As we know that the slowdown in results is after the slowdown in new orders, we now want to know if it has started.

Here is a graph that clearly demonstrates that the peak of the results took place in June 2022. I am talking here about the results of the entire S&P 500 index, since it represents a good part of the overall economy. We went from growth of +10% in June/July to +4.5% in October, which is not negligible.

Source : Reuters

At the global level, we can also see that the global MCSI index shows a slowdown of around 1.1%. Another important point, we have a considerable deviation from the average.

Source : livewiremarket

Until then, the financial results are not badly maintained thanks to the sectoral diversification of the S&P 500 index. The energy sector having contributed mainly to the performance for this year. Without it, earnings growth would already be negative.

With the drop in raw materials during the third quarter, this may affect companies’ results for the coming quarters.

Moreover, when we look at the graph below on global manufacturing (world level), we can see that for 57% of companies, the financial results are at contraction levels (below 50) in September. A meteoric rise since June.

Above 50 = expansion, and below 50 = contraction.

financial results, risk, recession
Source : Twitter

Growth in financial results stimulated by low interest rates

During the last decade, i.e. after the 2008 financial crisis, we have had a fairly accommodating monetary policy from central banks. Rates have been kept between 0% and 2% for several years, which has boosted earnings growth quite a bit in recent years. It is not a question here of low rates, but also of liquidity injections in 2009 and 2020 in order to revive growth.

The last injections in 2020 paired with 0% rates gave the financial results a huge boost. It can be seen under the following graph, as the deviation from the average is quite impressive.

The risk of retracement in the event of a recession can be quite brutal at the level of the S&P 500 index.

Why is the US dollar impacting the results?

The year 2022 has been a very positive year for the US dollar. This is itself stimulated by the Fed’s restrictive policy this year.

During the third quarter, the dollar gained 16.7%, hence the drop in results from June to October, from growth of 10% to 4.5%.

US dollar, earnings, profit, recession, crash
Source : Reuters

The dollar is an important major factor on the results, because a very large part of the companies of the S&P 500 have a supply/demand at the international level. If the dollar rises against other currencies, for example the euro, and Europe is a major client of S&P 500 companies, this will impact results. Why ? the goods or services become too expensive by making the conversion.

And besides, we can see all the currencies having real difficulties against the US dollar. As the rise in the US dollar was boosted by the Fed’s rate hike, the question is whether it will pivot. This would lighten the value of the US dollar. However, until inflation is under control, this is unlikely.

Conclusion

Earnings growth is currently at 4.5%. Given the increase in new orders (leading indicator), this figure is likely to increase towards 0% in the coming months. If the FED continues to keep rates high with a strong US dollar, the results could turn to recessionary levels.

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