Stock markets have continued on a positive note on the eve of the earnings season.
This week, the earnings season gets intense. In Finland, Nokia publishes its results, and whereas globally, Microsoft, 3M, Danaher, Tesla and Chevron publish theirs. Due to the later parts of the week being busy, the second What’s Up with Stonks of the week will exceptionally be published tomorrow.
In this post, we talk about the earnings season for the Helsinki Stock Exchange. Expectations are for negligible earnings growth. Then let's see how the world's largest asset class, housing and real estate, continues to melt. Before that, let's go through a few key miscellaneous topics.
Key miscellaneous topics from the market
This is a more technical indicator, but last January the stock market rally has been exceptionally strong, especially below the surface. This graph by Ryan Detrick shows the ratio of rising to falling stocks on the New York Stock Exchange over a 10-day period in January and historically corresponding strong 10-day periods. There have been 14 previous such strong rallies, and 13 of these have been followed by further rises over the one-year period. The one exception is the 1987 super-collapse. On average, the stock market is 18% higher 12 months later. Many of those moments have come at times when the stock market has been cheaper, or the central bank has given support to equities.
Recently, big tech companies such as Microsoft and Google have announced major layoffs. This has led investors to debate whether unemployment will now become a scourge in the US. However, so far the jobless claims, which come in at around 200,000 per week, don’t reflect these individual layoffs of more than 10,000 people. It’s also worth bearing in mind that even the tech giants didn’t escape over-investment during the pandemic as they recruited tens of thousands of new employees.
Speaking of over-investment, here is an interesting graph of the annual growth of software and equipment investment and its ratio to GDP. The pandemic-era turmoil was by no means at the level of a tech-bubble, but it wouldn’t be surprising if tech companies face a period of drier demand after this saga. This information is probably already visible in the radically lowered share prices of tech companies.
Overview of the earnings season in Finland and the Nordics
The Helsinki Stock Exchange's earnings season accelerates this week, with Nokia, Kone and Evli, among others, publishing their results on Thursday (like you can easily see from Inderes' financial calendar).
Last Friday, Ericsson published its results, which give an indication of Nokia's prospects. Ericsson's operating profit was well below the consensus forecast. In the network unit, profitability is under pressure as the focus of revenue shifts from North America to the Indian market. The same shift will also put pressure on Nokia. Despite the metaverse hyped by investors, Ericsson is forecasting a 1% decline in the market this year. Thus, in order to grow, Nokia and Ericsson need to capture market share from others, such as the Chinese company Huawei.
Similarly, Metso-Outotec got a foretaste of things to come from the Swedish conglomerate Sandvik. Half of Sandvik's revenue comes from the mining industry. In Swedish style, Sandvik's profitability was at an excellent level in terms of both operating profit margin and return on capital. However, according to analyst Erkki Vesola, there was some softness in market comments. Order intake for mining equipment declined organically by a few percent year-on-year, although excluding Russia the change turns positive.
Let's look at Inderes analysts' expectations for the Helsinki Stock Exchange's performance season as a whole. The good news of this earnings season should be an easing of cost pressures and component shortages, but at the same time companies are facing a weaker demand situation. Many companies have suspiciously high inventory levels, which inevitability brings to mind the risk of write-downs. Inderes monitors around 150 companies, the majority of which are small. Therefore, this data should be considered as indicative. The median annual increase in operating profit is expected to be only 1%, which means that, taking inflation into account, companies' earnings power will decline in real terms. Revenue is expected to grow by around 8%, which would mean a deterioration in profitability on average. Thus, additional revenue isn’t necessarily very valuable.
At the heart of the Q4 results is, of course, the outlook as investors look to the future. As usual, analysts expect strong earnings growth this year, with EBIT forecast growing by an average of 12%. I have learned over the years that at Inderes and other analyst houses, a 10% or so increase in earnings is a kind of standard, which then tends to go down when the reality turns out to be more modest than expected. This graph shows how the consensus earnings growth forecast has evolved each year for the S&P 500 index. In the last 10 years, 2017 seems to be the only year where the results came close to the initial expectations for the year.
Earnings growth expectations seem high, even though the worst economic threats in Europe have receded for the time being. Recession speeches are retracted daily in the media. At the same time, it’s worth remembering that inflation of almost 10% should balloon growth in nominal terms. If earnings continue to develop well, I must raise my hand in error when in the fall I questioned the strong earnings growth expectations for Finnish and European equities on the eve of the energy crisis. However, let’s not count our chickens before they hatch.
Of course, one earnings period is only literally three months of development, as the present value of a listed company derives from its future cash flows for decades. Therefore, what matters most to investors in earnings reports are the factors that affect their estimates of a company's performance over its entire life cycle. This also explains why price reactions can be strong in one direction or another as investors revise years of expectations based on a single quarter.
World's largest asset class is melting away
The meltdown in the world's largest asset class—housing and real estate—has continued, although recently many stocks in the sector have seen an optimistic rally from the bottom as investors anticipate a fall in interest rates.
In Sweden, for example, house prices are expected to fall by 20% from their pandemic peaks, but the phenomenon is global.
Equity investors should also keep a close eye on this asset class, as housing is an important part of people's wealth, and its decline can be quickly reflected in consumer spending. At the same time, real estate construction is an important part of the economy. It’s been said that the economic cycle is the same as the real estate cycle.
In the stock market, the end of the zero-interest period has caused a sharp and rapid bear market, but as there is limited debt investment in equities, the impact is usually limited to bad sentiment.
In contrast, the real estate sector is massive, you can't get rid of real estate in seconds like you can stocks, and you operate with a big debt leverage. In the worst case, the collapse triggers a domino effect, where banks demand more collateral, forcing investors to fire sell properties, which in turn deflates their prices, forcing banks to demand even more collateral.
In the world's demand powerhouse, the US housing market is already in virtual recession. This graph shows how many homes are for sale relative to how many have been sold. The ratio is now just under 9, on a par with the financial crisis and numerous other recessions. When home sales slow down, there is downward pressure on house prices. On the bright side, however, inflationary pressures should also come down as the hangover in this sector spreads with a lag, like after a month-long bender in Ibiza. The fixed interest rate on a 30-year mortgage is now hovering at over 6%, so it’s understandable why homes don't want to sell.
The oversupply of housing is also reflected in the mood of builders, which is reflected here in the builders' confidence index, which is at the level of previous downturns.
A reassuring fact in this area is that, as far as I can see, there hasn’t been excessive real estate construction. Compared to the peak of the housing bubble, housing starts have been more moderate in recent years.
Bloomberg had a calculation that if household incomes continue their positive trend and mortgage rates fall to 5.5%, house prices would have to fall by at least 15% to bring prices in line with household incomes, in terms of the longer-term average.
As I have pointed out before, this time mortgages have been granted mostly to people with good credit ratings, and banks are more solvent than in the financial crisis, so a similar storm shouldn’t be expected in the light of current data.
The housing market isn’t the only source of problems in the US or elsewhere in the world. Bloomberg estimates that the real estate sector globally has $175 billion of bad debt, the recovery of which is questionable. The global monetary dry-up and rising interest rates have hit the over-leveraged real estate sector hard. For example, commercial property prices fell by 20% in the UK and 9% in the US in the second half of last year. Last year, Chinese property developers with Evergrande leading the way were top of the headlines, but speculation elsewhere has also been rife during a period of zero interest rates.
In Europe, the default risk of junk bonds of real estate companies is much higher than in other sectors, as can be seen from this graph. In Sweden, companies sell property to service their debts. Even in Finland, the share prices of many real estate players and developers have collapsed, such as Kojamo or Toivo Group. According to Bloomberg, this year the European real estate sector will have €390 billion of loans maturing. Banks have become much stricter in their lending criteria, making it more difficult to refinance debt. It will be interesting to see how the real estate sector will fare if the tight financial conditions persist for longer.
Even in the midst of the storm, it should also be pointed out that these real estate indicators and share prices have plunged to such depths that it wouldn’t be surprising if a turn for the better were already at hand. For example, shares in the European real estate sector are languishing at ten-year lows. Of course, hard times are a delicious buying opportunity for investors with plenty of cash.
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