Blog Hero Image

Posted by Craig Basinger on Feb 22nd, 2022

Great Fundamentals, For Now

Over the past few years, a common chorus has been that fundamentals just don’t matter in this current market environment. It is all about the macro, the Fed’s balance sheet, liquidity, money flows, and performance chasing. We would agree with this assessment: fundamentals have taken a back seat to big macro. But now, with yields rising and liquidity being pulled back, fundamentals may start to matter more.

The good news is fundamentals for the equity markets are actually looking pretty good. We have just about completed the Q4 earnings season, and it was once again another great season – with over 80% of companies reporting, 78% beat earnings estimates and 70% beat top-line sales forecasts. Relative to Q4 2020, earnings are up a whopping 28%, and sales are up 16%. That is fantastic growth and evidence that while costs are rising, top-line revenue growth is helping offset them. Companies are essentially passing on higher costs to the end consumer, in case you hadn’t noticed.

S&P 500 margins have jumped thanks to rising sales growth which has more than offset rising costs

Operating margins for the S&P 500 are higher than at any point over the past 30 years, as is sales growth. Because of the operating leverage within most companies, there is a solid relationship between sales growth and margins. Sales growth is benefitting not just from good economic activity but inflation. Margin improvement has been rather pervasive, with 10 of 11 sectors enjoying improving margins in 2021. The one exception was utilities.

The TSX is enjoying similar trends of late, with strong earnings and sales growth with good margins. The fact is, 2021 was a stellar year for North American equities. As we have highlighted a few times, this was partly due to the pandemic changing consumers and companies' behaviours.

Valuations provide more good news

If you combine the varying pullback in markets since the start of 2022 with the strong earnings growth, valuations are actually getting interesting. The S&P 500 is now trading just under 20x, its lowest since coming out of the pandemic induced bear market. Canada is below 15x, which is below its long-term average. Looking at Europe, Asia, and Emerging Markets (EM), the valuation froth is no longer an issue.

Price pull back plus earnings growth

But where does the buck go next?

One reason valuations have likely come back down is that the outlook for earnings growth is starting to lose pace. U.S. GDP is forecast to slow from 5.7% in 2021 to 3.7% this year and 2.5% next year. As a result, inflation is forecast to slow as well. Combine those with costs that are still likely rising, and you can imagine these record-high margins may be at serious risk of coming back down fast.

To give you an idea how fast this may decelerate, S&P operating earnings grew by over 60% in 2021. Sure, that was compared with 2020, but this growth is forecast to slow down to 9% in 2022. And that deceleration hits in Q1.

Investment Implications

This year has a lot of significant macro events going on. Going back to the office appears to be one; central banks changing direction on stimulus is another. However, slowing growth does not seem to garner much attention. While not negative growth, slowing growth along with stimulus removal makes for a more challenging market. Mark my words: it won’t be long before people start talking about a ‘hard or soft landing.’

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Sources: Charts are sourced to Bloomberg L.P.

The content of this document is for informational purposes only, and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.

Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

Craig Basinger, CFA

Craig Basinger is the Chief Market Strategist at Purpose Investments. With over 25 years of investment experience, Craig combines an educational foundation in economics & psychology with years of experience in both fundamental and quantitative research. A long-term student of the markets, Craig’s thoughts and insights can be seen in his Market Ethos publications and through his regular contributions on BNN.

Craig and his team bring a transparent and cost-efficient approach to investment management. The team provides asset allocation OCIO services and directly manages over $1 billion in assets. The team manages dividend mandates, quantitative risk reduction strategies and asset allocation services.