Source: Zhitong Finance
Author: Rousseau
Against the backdrop of the Fed maintaining high interest rates for a long time, corporate bonds worth about $82 billion will expire within the next 12 months; at the same time, the borrowing costs faced by S&P 500 companies will rise to their highest point in more than 20 years.
Global stock markets such as US stocks, which have refused to yield to the highest US bond yields since 2007, are now facing a new test: third-quarter results will reveal how much impact rising borrowing costs have on corporate profits as the Fed raises the benchmark interest rate to a 22-year high — 5.25%-5.5%, and how much impact they will have on the valuation levels of large technology companies, the main force driving US stocks into a bull market.
Some statistics show that in the context of the Fed maintaining high interest rates for a long time, corporate bonds worth about $82 billion will expire within the next 12 months; at the same time, the borrowing costs faced by S&P 500 companies will rise to their highest point in more than 20 years. The “anchor of global asset pricing” continues to be at a high level since 2007. There is no doubt that these factors will affect the overall valuation level of the S&P 500 index.
The impact of high interest rates on the US stock earnings season should not be underestimated!
As earnings season kicks off, business managers may be asked how long balance sheets can withstand the pressure of high interest rates. Recently, Fed officials have frequently sent higher for longer signals, that is, maintaining high interest rates for a long period of time. Generally speaking, the longer interest rates remain high, the global “risk-free yield benchmark” — 10-year US Treasury yields, will also remain high, and the pressure to refinance debt will become heavier. Furthermore, new projects may be delayed under the pressure of high interest rates, thereby reducing the scale of investment companies make in future growth.
About $820 billion in US and European non-financial corporate bonds will mature within the next 12 months. According to data collected by Bloomberg (Bloomberg), this represents about 7% of this type of market. Although companies are generally not expected to encounter maturity barriers until 2025, debt-ridden businesses are already feeling the pain caused by rising interest rates.
“For several quarters, a sword of Damocles has been hanging over the heads of highly indebted companies,” said Patrick Armstrong, chief investment officer of Plurimi Wealth. “The latest earnings season is likely to bring this sword down.”
Goldman Sachs Group strategists, led by David Kostin, recently warned that the year-on-year increase in borrowing costs for S&P 500 companies has reached the highest level in nearly 20 years. They said that the return on net assets index (ROE) contracted by 69 basis points in the first half of this year, with nearly half of this year coming from an increase in interest expenses.
Since the global financial crisis, falling interest costs and rising leverage ratios have accounted for nearly one-fifth of the 8.8 percentage point ROE growth rate of S&P 500 companies. The strategists added that the risk that interest rates will remain high for a longer period of time may prevent companies from increasing leverage, thereby hurting long-term profitability.
However, the basic prediction of Goldman Sachs strategists such as David Kostin is that the profit indicators of S&P 500 companies will bottom out this year, and there will be moderate expansion in 2024 and 2025. “We expect profit margins in the S&P 500 index and most sectors to remain near 10-year highs,” Kostin and other strategists wrote in a report on Friday. “Although the easing of investment cost pressure and operating leverage should support profit margins, it seems unlikely that profit margins will increase significantly due to flexible wage increases and rising interest rates and taxes.”
Marija Veitmane, a senior multi-asset strategist from State Street Global Markets (State Street Global Markets), said that compared to industries related to business cycles and economic growth, broad-cap constituents of US stocks with strong balance sheets are a safer bet. “We expect the economy to slow sharply next year, so we are likely to see very relatively conservative guidance from management.” Strategist Veitmane said.
At a time when the “anchor of global asset pricing” is raging, will earnings that exceed expectations become a “savior” for US stocks?
Currently, bulls in risk assets such as US stocks are hoping for a rebound on performance “Beat All” — that is, betting that performance exceeds expectations is the most important influencing factor, and the impact exceeds any macroeconomic and other factors.
Large-cap stocks, which account for the majority of weight, especially large technology stocks with higher valuations of US stocks, are currently suffering the negative impact of high interest rate risks. The high valuations of growth stocks such as Nvidia (NVDA.US) and other technology stocks are largely due to strong expectations for future profits. However, during the performance vacuum, when 10-year US Treasury yields, which have the title of “anchor of global asset pricing,” soar, the valuations of these growth stocks will be severely suppressed, making it seem that they no longer have strong investment appeal.
There is at least one reason for optimism for bulls hoping for US stocks to come out of the worst month of 2023: the overall profits of S&P 500 companies are expected to rebound sharply starting in the fourth quarter.At a time when 10-year US Treasury yields, which have the title of “anchor of global asset pricing,” soared (in October to their highest level since 2007), the US stock benchmark index, the S&P 500 index, fell into a wave of sell-off that lasted two months, with a decline of nearly 5% in September.
Judging from the DCF model, although the 10-year US Treasury yield, which is equivalent to the denominator R index in the DCF valuation model, continues to be at its highest point since 2007 and remains stable at a high level, if the cash flow expectations on the molecular side continue to recover upward, it can greatly increase the pricing range of risky assets such as stocks, which is, the valuation level of risky assets. However, molecular cash flow expectations are largely based on the performance of the earnings season, so the upward revision of corporate profits, especially whether the earnings per share indicator exceeds the general expectations of analysts, is critical to global risk asset pricing trends such as stocks.
Currently, the expected price-earnings ratio of the Nasdaq 100 stock, which is the trendsetter for global technology stocks, is 23 times higher than the S&P 500 index, and the valuation of the S&P 500 index itself has also been boosted by the high valuations of technology stocks such as Nvidia, Tesla, and Meta. Judging from sales expectations, the market sales rate of the NASDAQ index is close to 4 times, almost double that of the S&P 500 index, which is the benchmark for US stocks.
Last week, Société Générale strategist, led by Manish Kabra, wrote in a report: “More than 70% of valuations in the S&P 500 index are driven by long-term performance growth prospects, so when the anchor of global asset pricing surges sharply in the short term during the performance vacuum, the US stock market often subsequently enters a downward trend due to valuation hits.”
Meanwhile, the stock risk premium index, which measures the difference between the expected returns of stocks and bonds, is being sharply squeezed, prompting investors to withdraw from the stock market. Emmanuel Cau, a strategist from Barclays Bank, said, “Under the benchmark situation where interest rates will be high for a long time in the future, changes in valuation levels are even more important for stock market investors.”
Therefore, after the financial season officially arrives, when the S&P 500 component companies announce their actual Q3 results and Q4 profit guidelines one after another, data that meets or even exceeds analysts' expectations is expected to greatly boost US stock investment sentiment. For a stock market that is relentlessly looking forward to the future, one of the key reasons for being bullish is that corporate profit levels will resume their growth trend starting in Q4 this year — this is also an important logic that supports the high valuations of large technology stocks such as Nvidia, Tesla, and Meta.
Another important logic is that analysts' optimistic profit expectations for S&P 500 companies mean that it is only a matter of time before the bullish trend in US stocks fully arrives.Judging from the long-term investorist framework, as the market aggressively sets high interest rate expectations in the near future, a sharp pullback will create a rare buying opportunity. Mark Newton, a global stock strategist at US investment agency Fundstrat, said on Tuesday that US stocks are in the process of bottoming out, which means investors may soon see the perfect bargain buying opportunity.
Furthermore, according to the Bloomberg model, the performance factor may have a greater impact on the interest rate on stock prices during the earnings season.According to the latest expected data from the research institute FactSet statistics,Wall Street analysts generally expect the overall earnings per share (EPS) of the S&P 500 index to enter an upward channel.
Goldman Sachs recently said that judging from the past situation, the earnings season is likely to be a good harvest period for US stocks, especially for tech giants. Goldman Sachs said that history shows that the upcoming third-quarter results may catalyze a reversal in the momentum of large technology stocks. Since the fourth quarter of 2016, the performance of large technology companies has exceeded analysts' general expectations for 81% of the time.
In terms of FactSet statistics, Wall Street analysts generally expect the overall earnings per share (EPS) of S&P 500 companies in the third quarter of this year to fall 0.3% year on year, but revenue is expected to increase 1.7% year on year;For the fourth quarter of 2023, analysts generally expect EPS to increase 7.8% year on year and revenue increase of 3.9%; for 2023, analysts generally expect EPS to grow 0.9% and revenue to increase 2.4%; for the whole year 2024, analysts are also extremely optimistic. They expect EPS to grow 12.2% year on year and revenue increase 5.6%.
Editor/Somer