The two main issues investors are grappling with are (i) resetting interest rate expectations and (ii) resetting earnings expectations.
Is the year-end consensus price revision a card?
At the beginning of December 2022, two views were gaining consensus in the market.
Bullish Fed Pivot.
Relaxation of China’s zero COVID policy will lead to China’s growth recovery.
Both of these aspects are expected to boost the market and the global economy heading into 2023.
For the past two weeks, towards January 23rd, vague clouds have surrounded these consensus views.
Two back-to-back inflation rates were surprisingly positive ahead of the December 14th Fed meeting, prompting markets to begin pricing in a bullish Fed pivot in 2023 (either to support growth or fight inflation). I was. The pace of rate hikes further entrenched these expectations, partly because the market priced in two rate cuts for him in the second half of 2023. At the policy meeting on December 14 and the press conference that followed, Powell steadfastly dismissed the dovish expectations. Chair Powell emphasized the following message: No rate cut in 2023, the pace of rate hikes is less important than the level of the final rate, the length of the final rate and the ongoing quantitative tightening. This caused a stock market correction.
In our view, the Fed could pause about 5% if inflation continues to show positive surprises from Q1 to Q1 2023. From Q2-2023, base effects should emerge and inflation should slow significantly.
Global fears surrounding the spread of Omicron’s BF7 variant are creating uncertainty as COVID surges rapidly among the Chinese. Despite the reopening, it is important to monitor the nature and scale of the stimulus measures implemented by the Chinese government.
What does this realignment of consensus mean for the earnings cycle?
Macro indicators point to a slowdown in the global economy, but risks appear to be accelerating downwards into 2023. A sharp slowdown in inflation should ease the central bank’s hawkishness from Q2-2023, but the impact on corporate earnings growth will be slowing demand. Constraints on the supply chain have eased significantly, and increased inventories could put pressure on end-market pricing at a time when demand is subdued.
Negative operating leverage during the first half of 2023 could see earnings downgrades as the macro backdrop worsens. Global stock markets could face bad weather in the first half of 2023 as recession risks rise and earnings downgrade cycles continue. But I’m optimistic about the bottom of the cycle from Q2/Q3 to Q3 2023. Inflation is largely in the central bank’s comfort zone, and China’s Covid restrictions will ease significantly in the second quarter, which could help the recovery.
Historically, consensus earnings downgrades have been driven primarily by margin compression rather than earnings weakness. In India, excluding financials, margins have compressed to 500bps in Q22023. This means companies have historically had more cost issues than demand issues. If the recession turns out to be more severe than the market’s current expectations, the earnings revision will also be negative.
What is our view of India?
As 2023 progresses, key investor discussions will focus on falling commodity prices contributing to a positive earnings revision and weakening demand weighing on earnings. likely to get worse before it improves. India should continue to benefit from economic resilience and lower oil prices in a hostile global environment. Portfolio inflows over the past six months have resulted in higher valuations relative to global and emerging markets. Depending on how the cyclical upturn progresses, Indian valuations her premium will shift accordingly. India’s main risks are oil prices, current account balance and INR.
*Author Vinay Jaising is MD, Portfolio Management Services, Services)
