Watch commodities for signals, Chinese tech selloff, Earnings Watch

Another way to look at equity market risk is by observing spread between US inflation and the US earnings yield (inverse P/E ratio). The current P/E ratio has reached its biggest negative spread to the historical relationship between inflation and equity valuation. There are several ways to read this chart. One is that investors are believing inflation will quickly come down to 2-3% and stay there thus quickly pushing equity valuations back into the “safety zone”. Second, equity valuations are significantly out of line with the underlying inflation and as soon as the market gets its eureka moment that inflation is more structural then equities could easily decline another 15% without it being outrageous. The middle ground interpretation is that we will move in a 45-degree angle from the orange dot towards the regression line, which would reflect a combination of lower realized inflation but higher long-term inflation expectations and thus a repricing of US equities towards lower P/E ratios.

Chinese technology stocks are difficult this year

Chinese technology stocks had an ugly Friday session as new policy on Friday is aimed to curb fees of delivery companies hitting stocks of Meituan. The leading Chinese technology index, Hang Seng Tech, was trading lower again today down 49.5% from the weekly peak back in February 2021. Chinese equities have generally been hit by a slowdown in economic activity, a brewing housing crisis related to the country’s big real estate developers, and an energy crisis impacting industrial profits. But technology companies have in addition been hit by technology regulation aimed to tame the market power and anticompetitive behaviour of large technology companies. This has lead to a severe growth slowdown for Chinese technology companies and the worry is that regulation of the industry is not over yet. Our view is that Chinese technology stocks might look cheap but that it is likely a trap for investors as a lot of negative sentiment could hit Chinese technology stocks until we get on the other side of the CCP Party Congress in October.

Earnings this week and the profit margin squeeze

This week will see another roughly 200 earnings releases out the 2,500 earnings releases we track during the earnings season. The US earnings season is mostly done leaving the stage for European and Chinese equities, and this week will see several important earnings releases across many different industries. We will be closely watching earnings from HSBC, Home Depot, MercadoLibre, Rio Tinto, Danone, Booking, eBay, Saint-Gobain, Alibaba, Block, Moderna, Coinbase, BASF, Amadeus IT, and Li Auto.

Home Depot is a key earnings release related to the US housing market which is currently on fire despite mortgage rates have increased 100 basis points this year. MercadoLibre is South America’s largest e-commerce company and is part of our e-commerce theme basket which has been under pressure this year and thus there is a lot of attention on e-commerce companies. Rio Tinto has a large footprint in the global mining industry and can give us new insights into the supply and demand imbalances. Danone is a large food company and thus can provide colour in inflationary pressures in consumer foods. Saint-Gobain is typically not a company we watch but with galloping prices on construction materials this earnings release will be more interest to watch than normal. This week’s most important earnings release will come from Alibaba on Thursday which will set the tone for Chinese technology stocks in the weeks to come. On Thursday several US technology companies such as Block, VMware, Autodesk, Dell Technologies and Coinbase will report earnings.

The most important take away from the Q4 earnings season is the contracting net profit margin which is declining for the second straight quarter in the MSCI World Index to 10.8% in Q4, which is the fourth highest reading since early 2003. We expect the net profit margin to continue to mean-revert towards the long-term mean at 7.5% suggesting a whopping 3.3%-points headwinds for global companies adding to the downward pressures in equities.

The most important earnings releases next week:

Monday: Williams Cos

Tuesday: Hang Seng Bank, HSBC, ASM International, Norsk Hydro, Home Depot, Medtronic, MercadoLibre, Palo Alto Networks, Agilent Technologies, Mosaic

Wednesday: Rio Tinto, Danone, Munich Reinsurance, Barclays, JDE Peet’s, Iberdrola, Oversea-Chinese Banking, Lowe’s, Booking, TJX, Stellantis, eBay

Thursday: Anheuser-Busch InBev, Royal Bank of Canada, Canadian Imperial Bank of Commerce, AXA, Safran, Saint-Gobain, Deutsche Telekom, Sun Hung Kai Properties, Hong Kong Exchanges & Clearing, Anglo American, Lloyds Banking Group, BAE Systems, Alibaba Group, Intuit, NetEase, EOG Resources, Block (formerly Square), Moderna, Newmont, Keurig, VMware, Autodesk, Dell Technologies, Monster Beverage, Coinbase, Zscaler

Friday: BASF, Amadeus IT, Holcim, Swiss Re, Sempra Energy, Li Auto