Outlook for market darlings is less than optimistic

It was a record-breaking US reporting season by all accounts. So much so, that when I sat down to chat with Bruce Apted, head of active quantitative equity for State Street Global Advisors, he was still reeling. 

“You almost have to check your typing because these are such big numbers," he said. 

The US is now well ahead of Australia in its reopening play. After an incredibly tough downturn in 2020, it's no wonder the numbers look bigger and better than ever. This time 12 months ago, few were anticipating how forceful the economic rebound would be. 

Earnings per share (EPS) estimates have had around a 90% increase at the market level, Apted reported. The energy sector is up 250%; industrials up 260% at the market level as well. 

That's not even the most interesting part, he said. The real question is what we can learn from these numbers. 

In this video, Bruce Apted gives the best lessons for investors about how to navigate a steady course through reporting season, and other periods of volatility caused by "knee-jerk" reactions to investor news. 

This transcript has been edited for clarity.

Mia Kwok:
Bruce, we're in the middle of reporting season right now. What are some of the trends that you're seeing coming out of reporting season?

Bruce Apted:
Yeah, that's a great question. We're certainly seeing lots of records being broken when it comes to reporting season. I'm talking about the global reporting season here. We can look to the global space to get insights as to what might be happening in the Australian reporting season.

So maybe just a couple of highlights in terms of these records being broken. Certainly in terms of EPS estimates, year-on-year, we're seeing numbers around 90% increase at the market level. So these are almost like you want to check your typing and make sure you've got it right, because these are such big numbers. 

But because the base effects are coming through as well, we're looking at from 12 months prior when the economy was in a very different shape to it is now. So we're seeing very large percentage increases historically.

And if you look across the different sectors, you see that the most cyclical sectors, the ones that were genuinely hurt the most during 12 months ago, are the ones that have bounced back the most in terms of percentage terms. So to give you a sense of that, the market level's up 90%, but the energy sector, for example, is up 250% from those periods and industrial stocks up 260%.

So, that gives you a sense of some of the things we're seeing. But I suppose to me, that's not quite as insightful. I think what's more interesting is what's happening in terms of guidance statements from companies; what companies are actually focused on when they're talking to their investors. All the extra information that's more forward-looking.

So one of the surprising things that I think came out of reporting season was that some of the darlings like Amazon, for example, actually posted very strong historical numbers, but on a forward looking basis provided a guidance that was less optimistic. And we actually saw earnings revisions come down in that name and in fact, across that sector on average.

One of the things we like to look at is price reactions to the stocks on the day of reporting. A huge amount of information gets given to investors on the day of reporting. And when the market digests that we get a sense of whether they thought that was positive or negative, and it takes into account so many different things. 

So it's quite a nice thing to look at. And when we look at those themes, we actually found that actually some of the more high-flying sectors didn't do so well, and the tech sector being one of them. And actually, some of the more defensive sectors actually did better. So, that's an interesting insight. And I think that does have implications for the Australian market as well.

What are some of the price reactions that you're seeing? Do they tend to "buy the rumour and sell the fact"? Or are they actually seeing that people are enthusiastic about the forward guidance?

Yes, so it's an interesting one. And I think that you hit the nail on the head there with the buy the rumour, sell the fact. 

I think that's something that we always want to be cognizant of in international markets because that's the way they work. They're very forward-looking. It's not what you're reading about in the paper that's most relevant. It's about that forward-looking perspective.

And I think that's one of the things that the market's starting to focus now on what's called peak cycle earnings. It's not that hard to actually think about that because you've got ... 

When you've had a 90% increase in your earnings at the market level, where do you go from there? And in fact, if you actually look at what the consensus has got built into it, 12 months onward from that we're seeing growth rates closer to 6%.

So what that means is those rates of growth, they're still going to be positive and the environment's still positive for earnings, so no questions. But the rates of growth are coming down. And we've seen that across all sorts of economic variables, whether it be inflation or GDP, the rates of growth are starting to come down. 

And so that's got people talking about peak cycle in terms of those earnings growth rates. And so that has implications for different parts of the market. And we started to see that in July where we basically saw some of the more defensive sectors actually start to do a bit better, relative to some of the more cyclical sectors. 

There are always so many different results; it's hard to generalise precisely, but that's a generalisation that we definitely saw.

Seeing these results can often cause a bit of a knee-jerk reaction for investors. How would you recommend that investors taking this information and how to react to it?

Yeah. So I think that's a great question as well. And I think earnings season and investor reactions to news is one of the things that we look to create... We look for that: creating mispricing insecurities that we can then take advantage of. 

So one of the human failings, if you like is our focus on what's right in front of us. And I think it has many years of evolution and hundreds of years, thousands of years of evolution, which has led us to be very short-term focused as humans. 

And we are so when we look at the investment markets as well.

And so earning season is a classic example where there'll be some short-term aberration in a stock. It'll have an earnings miss, for example. But that earnings miss isn't structural to the underlying business. 

So the underlying business is in fine shape; it might just have a short-term setback due to some supply constraint or some change with a customer. 

But the underlying business model is still intact. And the underlying valuation is still very valid, but we might see a short-term overreaction in stock prices or sell-off in the stock price, which creates an opportunity to buy into that business at a cheaper price, provided those longer-term fundamentals still stack up.

So that's, I think, certainly something we see at earning season. But also I think you do get a huge amount of information from management in terms of what they're seeing in the marketplace. 

And it's also interesting in the sense that you, because you're looking across so many different stocks and sectors, is you can get insights from looking across many different industries and how they're interlinked. And that's something we certainly do at State Street. 

We actually are monitoring signals across 16,000 securities. 16,000, that's a big number, right? It's not 1,600. It's a huge amount of securities. And there's a huge amount of information that we can take in across that.

Bruce Apted

Head of Portfolio Management – Australia, Active Quantitative Equity

State Street Global Advisors

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