Please see below article received from Legal & General yesterday afternoon, which provides a global market update and eases concern with regards to supply chain issues and inflation.
Don’t worry (much) about supply chains
Industrial companies are talking a lot about issues with their supply chains. But they haven’t taken the opportunity to change their guidance or deliver profit warnings. And market reaction to their comments was relatively muted.
We had a few companies with early quarter-ends give a flavour of what to expect from the rest of the reporting season. Of those early reporters, 74% beat analyst estimates and 80% outperformed the market the day after their results were released. Their figures cover a slightly different period than Q3, and while the sample is small, it looks somewhere between normal and better than average.
It also suggests that the disappointments from companies like FedEx*, Adobe* and Nike* may get the most attention but are not the norm.
There is clearly an impact on earnings from the supply chain bottlenecks, but so far it seems that the impact:
| 1. | is manageable for most companies |
| 2. | can be covered with their earnings buffer by most companies |
| 3. | is well anticipated and priced by the market |
Bottom line: Indications so far are that we are heading for a fairly normal earnings season, which has little impact on markets at the aggregate level.
Germany’s election
Germans went to the polls on Sunday and granted the Social Democrats (SPD) a narrow victory, with almost 26% of the vote. Their leader, Olaf Scholz, said he had won a mandate to form the nation’s next government. Support for outgoing chancellor Angela Merkel’s CDU/CSU appears to have plunged to a historic low of 24%. The Greens secured almost 15% of the vote.
This will only mark the start of what will likely become lengthy coalition negotiations. Last time, this took a record six months, and this year’s prospect of a 3-party coalition across the political spectrum feels like a recipe for long rather than short negotiations.
There would have been really only one properly market-moving scenario: a left-wing, red-red-green government – but the Left party appears to have fallen just under the 5% hurdle.
The SPD and Greens had previously made it clear that they were leaning towards a more centrist, “traffic light” coalition with the Liberals (FDP), who won almost 12% of the vote.
Emerging market equities – what are we waiting for?
It’s easy to be bearish on emerging market equities amid double trouble from regulatory and growth risks. Increasing regulation in China across many industries is hitting the outlook for profits, and the uncertainty over the extent and duration of the crackdown means investors require an additional discount on top of their future earnings base case. At the same time, economic growth has slowed in tandem with the delta outbreak, and we expect an underwhelming rebound in Q4 as temporary regional lockdowns are likely to be required for some time. Then there’s the spillover from Evergrande’s* problems to the important property sector. Those are all drivers behind our below-consensus growth forecasts.
But equity markets have reacted…a lot.
The correction in Chinese equities (H-shares, not A-shares) is now one of the biggest in recent history. The HSCEI index is around 30% off its February peak, making it the third largest drawdown over the past decade. Emerging market equities have also been affected, having trailed developed markets by 20%, the third largest underperformance over the past 15 years.
Sentiment has turned very bearish. In an extreme reversal, emerging market equities have gone from everyone’s favourite long at the start of the year, in sell-side outlooks and investor surveys, to being the least popular in the latest fund manager survey since their low in 2016.
Valuations paint a similar picture. Relative to developed markets, emerging market equities are as cheap across many multiples as they have been in well over 10 years. Some of that clearly reflects falling earnings expectations, but earnings estimates have some way further to fall before catching up with what prices have already reflected.
Some of this sounds like a bull case in the making, but regulatory uncertainty and our below-consensus growth outlook are some of the factors holding us back — for now, at least. Nevertheless, we are watching a number of potential catalysts and signposts that could change our position:
| • | President Xi or the Chinese government make a commitment to the private sector — and tech companies in particular. |
| • | Decreased sensitivity to regulatory news flow. We have seen some evidence of this in tech, but the price reaction to new sectors being targeted – e.g. casinos — remains severe. |
| • | A-shares selling off. The pain has so far been concentrated in H-shares. A-shares joining in the correction would be a sign of markets pricing the growth slowdown as much as the regulation theme, and a sign of domestic capitulation. |
| • | A larger-than-expected policy response to a slowdown. We expect policymakers to be slower than in the past in responding to stumbling growth, but evidence to the contrary would be a very positive catalyst. |
| • | Indications that our growth forecasts are too pessimistic and growth rebounds faster than we expect. |
| • | Vaccination convergence. Emerging market vaccinations are catching up with developed markets. |
Bottom line: Emerging markets and China equities are becoming more interesting in some ways, but given our macro views, we believe it’s too early to buy.
We will continue to publish relevant content and news throughout the coming Autumn weeks, so please check in with us again soon.
Stay safe.
Chloe
28/09/2021