Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Margin squeeze, EV battle, and energy capex drought
Peter Garnry
Chief Investment Strategist
Summary: The Q3 earnings season is showing that there is strong demand in the global economy and especially for technology services, but profit margins are under pressure due to rising input costs across commodities and wages. That will create a new and much more challenging environment for equities. Volkswagen has reported Q3 earnings today showing that the German carmaker is losing momentum against Tesla. Finally, we take a look a capital expenditures in the energy sector which are still at a five-year low and not indicated to increase significantly in the short-term.
With 40% of the S&P 500 companies having reported Q3 earnings we now have a good picture of the corporate sector in Q3. Revenue is up 0.2%, 1.5%, and 3.1% q/q for MSCI World, S&P 500, and Nasdaq 100 respectively indicating good momentum on the top line. However, earnings per share is rising much less and is even negative for MSCI World (-1.2% q/q), causing net profit margins to shrink for the first time in five quarters.
Rising energy prices and commodity prices in general will put enormous pressure on input costs. But as if commodity prices were not enough, wage pressures are also accelerating in many industries and recently the US quit rate (the percentage of labour force voluntarily quitting their work) has shot up to almost 3%, the highest level ever observed since the time series was started in 1999. In other words, companies are under pressure from all sides on their costs, and even interest rates are beginning to rise again. The last time we had a declining profit margin environment was from Q2 2018 to Q4 2019 before the pandemic were equities had a troublesome period only saved in the last months before the pandemic because falling interest rates were causing a “there is no alternative” trade in equities.
Volkswagen is losing momentum against Tesla
Tesla is on a tear recently due strong Q3 delivery figures, a big order from Hertz, and a new battery from its key supplier Panasonic. In that light, we were greatly anticipating Volkswagen’s Q3 figures today as the German carmaker is the only real contender today to Tesla’s rise in the transition to EVs. Volkswagen reported Q3 operating margin under pressure due to supply constraints on semiconductors, even the volume brand was making an operating loss in Q3. However, the CEO said that he expect the semiconductor constraints to start easing in Q4, and that 2022 will be a much better year than 2021 for the industry.
Volkswagen delivered 122,138 EVs in Q3 up only 10% q/q compared to Tesla’s 20% q/q gain driven by Tesla’s ability to write working software in just three weeks to circumvent a shortage for a specific semiconductor chip. While Volkswagen is losing a bit of momentum in the short-term we expect 2022 to the defining year for industry and where we will finally see whether Tesla is able to keep Volkswagen at the second spot in EV during ramp-up of production.
Lack of capex in energy and mining will continue to cause problems
This week we have had Equinor, Royal Dutch Shell, and TotalEnergies reporting Q3 earnings all beating expectations, and tomorrow we will get earnings from Exxon Mobil and Chevron. The conclusion from these large energy companies is that revenue and profitability are improving fast due to rising energy prices, but they are not willing to increase capital expenditures (CAPEX) despite the outlook looking strong. The two charts below show the CAPEX drought that we are currently facing in the world and which will continue to hold supply constrained amid rising demand. Global energy companies are currently prioritizing reducing debt, and paying back shareholders through dividends and buybacks of own shares.
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