Hedley Market Commentary - November 2021

With more than half of US companies now having reported profits for the 3rd quarter, it is clear that many are in rude health. Demand is strong in almost all sectors and while cost inflation and supply issues are still the main worry, companies seem to be navigating through them. There are of course exceptions to this, such as Apple, where the CEO reported that input problems had cost the company $6 billion as chip shortages and Covid related manufacturing disruptions had taken their toll.

However, while companies are reporting strong profits and analyst estimates are being beaten by 10%, which is above the usual 5% figure, this is down on the 20% recorded in the 1st and 2nd quarters of this year. More worrisome is the fact that estimates for the quarter we are in now are not being raised nearly as much as had been in the prior quarters. The earnings estimate for the fourth quarter now stands only marginally above the previous estimated number of a month ago, according to Refinitiv. This suggests that corporate America is not surprising analysts nearly as much as they had in the first half of the year, when many on Wall Street were taken aback by the strength of the economic recovery. For the moment at least, companies are having their cake and eating it, with higher sales and higher margins/prices leading to greater profitability but there is a limit to how far this can go as there will eventually be resistance to this from the customer.

The other major concern surrounds technology companies which have driven the market over the past few years as revenues and earnings have excelled. Many big tech names have disappointed this earnings season: Apple, Amazon, IBM, Intel and SNAP among them. Others have not: Alphabet, Microsoft and Shopify all reported strong numbers. However, many of the technology stocks have been held back by factors which may be transitory, such as chip shortages rather than demand, which remains strong. It is possible that many of them could therefore benefit in the 1st half of next year. However, valuations are being further stretched and although a number of these companies may well see better times ahead, it is the valuations which seems to be the biggest hurdle to get over, at least in the shorter term.

Finally, UK earnings too continue to recover well but despite this, the FTSE indices continue to lag other global benchmarks. UK earnings forecasts have risen sharply this year and the recovery and upgrades to profits outstrips all other developed markets and yet the lack of enthusiasm for UK stocks has created a further sharp derating of the UK market (see chart). However, the lack of high quality growth companies has proved a hinderance in attracting new investors, especially with the paucity of technology exposure. However, share buyback announcements continue apace, as do private equity incursions into the market, which should prove supportive over the medium term. It is possible however, that the catalyst may come from the UK’s huge exposure to the ‘old’, traditional world, which may bring about its revival. As the world moves to ESG (environmental, social, governance) investing there is great potential for companies here to break themselves up into more focused units and we have already started to see this happening, with positive impacts for shareholders. Could the very problem which investors dislike be the markets ultimate saviour?

This market commentary is not intended to provide information sufficient to make an investment decision.

All opinions contained in this report constitute Hedley & Company Stockbrokers Limited's judgment as atthe date of this report, and are subject to change without notice and are provided in good faith but without legal responsibility.

Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.