Good start to Q4 earnings and our hypothesis of interest rate sensitivity

Good start to Q4 earnings and our hypothesis of interest rate sensitivity

Equities 6 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  A bit more than 10% of the companies in the S&P 500 have reported earnings and so far the numbers are better than expected underscoring the continuing improvement in corporate profitability despite the ongoing pandemic and severe restrictions on mobility in the developed world. In today's equity update we also lay out our hypothesis for the interest rate sensitivity which we believe has gone dramatically over the years and is one if the most important risk sources in the equity market. We also explain the dynamics we expect to see before rising interest rates hit the speculative growth segment in equities.


Around 55 companies have reported Q4 earnings in the S&P 500 and the earnings surprise ratio is so far 90% while the positive revenue surprise ratio is 74%. In terms of revenue growth, the best sectors are consumer staples helped by stimulus checks and the health car and IT sectors. In the bottom of the revenue growth ranking we find energy and industrials. It is still early days, but the numbers so far indicate a good Q4 earnings season despite a more negative backdrop with the new lockdowns and restrictions in the developed world. The few earnings releases that we have got in Europe have so far also been to the positive side.

As we showed on Monday in our Q4 earnings week preview, earnings growth was stagnating before the pandemic and on a longer horizon since the financial crisis earnings growth is only barely positive for MSCI World in nominal terms. In other words, the lower discount rate is the key catalyst that has supported rising equity valuations and sustained the bull market. Our hypothesis is that the interest rate sensitivity in the equity market has gone up as we talked about in our note Democratic sweep, interest rate sensitivity, and reflation from 6 January.

The problem is that it is difficult to quantify as the long-term relationship is that higher interest rates come with higher equities (opposite of our hypothesis). One of the reasons for this relationship is that we have had 40 years of lower inflation and thus most periods of rising interest rates have been that of higher growth and less about inflationary pressures. Secondly, if we shorten the time period we look at, say only look at 2020 data, then the unusual market moves and big data outliers during the February and March selloff again makes it difficult to quantify our hypothesis.

Source: Bloomberg

Despite this we are still guessing that the interest rate sensitivity has gone up for two reasons. One, it explains the higher equity markets given the low earnings growth. Secondly, the significant increase in equity valuations of growth stocks with no earnings or expected cash flows far into the future have one of the best performing segments since rates began dropping in last 2018 until the pandemic hit the economy. But when will the market reach an inflection point on rates and impact the most speculative growth stocks (read our note Bubble stocks go into ‘hyperdrive’ mode)? So far, the 60 basis points move in the US 10-year yield since early August 2020 has not dented growth stocks. If growth expectations (see chart) measured by dividend futures on 2022 dividends are rising fast the higher discount rate is most likely cancelled by the opposite force of higher growth. When growth expectations slow and we still see higher interest rates coupled with higher inflationary pressures (energy prices, China PPI etc.) then the higher discount rate is the toxic one and we expect to see a negative to growth equities.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.