Thoughts on S&P 500 earnings and the bond market: Higher rates could wipe out strong earnings


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Treasury yield curve

Treasury yield curve

The beginning of this blog this week will be completely different, as we begin with some comments and thoughts on the bond market.

The spreadsheet above begins with the Treasury yield curve as of 10/31/21, just before Jay Powell and the FOMC announced the cut, the week of November 5, 2021 through Friday, January 14, 2022, closing.

Look at the evolution of the 2-year Treasury yield, just since January 1, 22:

  • The 2-year Treasury yield rose 4 basis points in November from 22 to 52 basis points;
  • The 2-year Treasury yield rose 21 basis points in December 22 to 73 basis points;
  • The 2-year Treasury yield rose another 26 basis points to 99 basis points in the first 14 days of 2022;
  • The 10-year Treasury yield rose 13 basis points on Nov 22 to 1.43%;
  • The 10-year Treasury note rose 8 basis points on Dec 22 to 1.51%;
  • The 10-year Treasury yield rose 26 basis points in the first 14 days from 22% to 1.77%;

The 10-year Treasury yield has now closed above the March 21 peak of 1.75% for two straight weeks.

Cumulative returns since the beginning of the year

Source of feedback data: Morningstar

This second spreadsheet was actually launched at the height of the market corrections in March 2020 and it is still updated today, every weekend. These bond funds attempt to cover all of the bond markets, although other data not shown does track the indices. The column on the right is the returns for the year 2021, but the next two columns show the returns for the first two weeks of 2022.

2022 could be tough for bond market asset classes, much like 1994.

BlackRock’s Rick Rieder and a slide from this week’s conference call:

Inflation indicators

BlackRock’s Rick Rieder

BlackRock’s Rick Rieder hosts a monthly conference call for investors and it’s one of the best 30-45 minutes spent each month. This Thursday morning, January 13, 2022, on page 7, Rick noted that it looks like many inflation indicators are starting to reverse, or the “rate of change” is starting to slow.

Details from Bespoke this week on tracking omicron data (p. 3 of the Bespoke Weekly Report, show that New York cases are starting to turn around.

What caught my eye was the top, middle or trend PCE chart.

S&P 500 earnings data:

  • The 4-quarter forward estimate this week rose to $223.57 from $223.25 last week and $216.14 two weeks ago. Remember that with each new quarter start, the forecast estimate increases sharply as the new quarter is added and the next quarter decreases.
  • The PE on the forward estimate is now 21x from the same multiple last week;
  • Earnings yield rose this week to 4.79% from 4.77% last week and 4.54% two weeks ago. Earnings performance could tell the story this year, if the S&P 500 falters and doesn’t produce the kind of historic returns it has (which we expect), and yet S&P 500 earnings remain robust. In other words, a stable S&P 500 amid strong earnings will see a “PE compression” and a rising S&P 500 earnings yield.

Friday Banking Earnings Commentary: The vagaries of reporting IBES data by Refinitiv Earnings are that weekly period measurements are discontinued on Thursday nights, thus Friday morning reporting during earnings season is not resumed in the numbers before the following week. Usually you don’t see a lot of Friday morning EPS reports, but 4 major financial companies did on Friday January 14, 2022, maybe because of the mid-January holidays every year.

Progression in the calendar estimate of the S&P 500 EPS 2022:

2022 S&P 500 EPS schedule estimate:

Source: BIES data by Refinitiv

This spreadsheet shows the trend for “estimated” S&P 2022 EPS as of Jan 14, 22, including upward quarterly estimates, since 10/31/21.

We (investors) will likely see smaller upside surprises and more “normal” EPS growth rates and earnings for the S&P 500 through 2022.

Summary / Conclusion: Due to the way Refinitiv reports data, we won’t see banking and financial reports and their influence on the S&P 500 EPS from last Friday until early next week (and the stock market is closed on Monday for Martin Luther King holiday), but then there are a plethora of additional financial earnings reports for Tuesday morning January 18, 2022, including Schwab (SCHW), Goldman Sachs (GS) and others.

By next week, investors will have a very good reading of the financial sector and its impact on the S&P 500 EPS. The financial sector now represents 11.5% of the market capitalization of the S&P 500.

The real point of today’s S&P 500 earnings update is that – no matter what the numbers tell us over the next 4 weeks – higher interest rates will impact valuation(s), and sector rotation and a transition from growth to value will impact stock prices, likely more than financial performance.

Clients are seeing reductions in “growth” and momentum positions over the past few years, which are being replaced by international equities, emerging markets ex-China and value stocks that did not participate in the post-March stock market rally 20, and even some gold for the first time since 2011.

The search for “uncorrelated” is activated – the inevitable rotation will occur.

There really isn’t much to add from an S&P 500 sector perspective: investors will have to see how the numbers fall and how stocks react. I don’t expect S&P 500 “Top 10” positions to trade well over the next 3-6 months, regardless of earnings.

Take all of this with a grain of salt and substantial skepticism. Past performance is not indicative of future results.

Thanks for reading.

Original post

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.


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