Skip to main content

Download

Audience for the document: Share Class: Language of the document:

Download

Share Class: Language of the document:

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the twenty four-year period ended June 30, 2020, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest

October 2022 / GLOBAL EQUITIES

QM Equity Quarterly Newsletter

Q3 2022

Key Insights

  • We expect the change in sentiment in the middle of the third quarter will persist into the fourth quarter, as Fed tightening drives earnings revisions.
  • Using our bottom-up knowledge of companies and historical data, we can frame an expected decline in S&P 500 earnings through the end of 2023.
  • Our outside view (using historical data over the last 15 years) suggests S&P 500 earnings for 2023 could fall from $241 to $210 per share.

Quarterly Factor Returns

(Fig. 1) July 1, 2022–September 30, 2022

Quarterly Factor Returns table for July 1, 2022–September 30, 2022

Past performance is not a reliable indicator of future performance.
Sources: Refinitiv/IDC data, Compustat, Worldscope, Russell, MSCI. Analysis by T. Rowe Price. See Additional Disclosures.
Factor returns are calculated as equal-weighted quintile spreads. Please see Appendix for more details on the factors.

Following the first-half sell-off, the third quarter of 2022 was a tale of two periods:

  • The beginning of the quarter was marked by “hope” that the Federal Reserve would engineer a soft landing and thoughts that sentiment had become too negative during the second-quarter market drawdown. This led to a strong market rally, falling U.S. Treasury yields, and leadership by high-growth, high-risk, and highly shorted stocks.
  • The second half of the quarter was a complete reversal, as the Fed reiterated its commitment to reining in inflation, which led to a steep market decline, rising interest rates, and leadership by high-quality and less expensive stocks.

S&P 500 Index vs. Interest Rates

(Fig. 2) July 1, 2022–September 30, 2022

S&P 500 Index vs. Interest Rates graph for July 1, 2022–September 30, 2022

Past performance is not a reliable indicator of future performance.
Sources: FactSet, S&P.

Looking at the time series, the market has been swinging between factors:

  • Risk, growth, and short interest have been abnormally correlated, as have profitability, size, value, and momentum.
  • These factor correlations contributed to the distinct “tale of two periods” shown in Figures 3 and 4.
  • The underlying driver appears to be interest rates and, relatedly, the market’s pricing of a potential recession in 2022–2023.

Russell 1000 Index Factor Performance

(Fig. 3) July 1, 2022–September 30, 2022

Russell 1000 Index Factor Performance graph for July 1, 2022–September 30, 2022

Past performance is not a reliable indicator of future performance.
Sources: Refinitiv/IDC data, Compustat, Russell, T. Rowe Price analysis. See Additional Disclosures.
Factor returns are calculated as equal-weighted quintile spreads. Please see Appendix for more details on the factors.

For the quarter, growth outperformed value, and optimism won the day. We are not convinced this will continue in the fourth quarter.

  • As shown in Figure 1 and the time series in Figures 3 and 4, despite the mid-quarter change in sentiment, the aggregate environment favored growth over value and risk over quality.
  • We see more uncertainty in the fourth quarter and beyond: Continued Fed tightening and rising rates should continue to challenge longer-duration and more expensive growth stocks, while Fed tightening economic implications should drive negative earnings revisions in more cyclical value stocks. Our expectation of negative earnings revisions is the subject of our Market Insight section.

Russell 2500 Index Factor Performance

(Fig. 4) July 1, 2022–September 30, 2022

Russell 2500 Index Factor Performance graph for July 1, 2022–September 30, 2022

Past performance is not a reliable indicator of future performance.
Sources: Refinitiv/IDC data, Compustat, Russell, T. Rowe Price analysis. See Additional Disclosures.
Factor returns are calculated as equal-weighted quintile spreads. Please see Appendix for more details on the factors.

Market Insight—What We’re Monitoring

In our second-quarter 2022 newsletter, we highlighted that the first-quarter market decline was driven entirely by multiple contraction and that we expected negative earnings revisions to drive the next stage of the market’s decline. That view has now become close to consensus.

S&P 500 Index Historical Earnings Revisions

(Fig. 5) June 30, 2008–September 30, 2022

S&P 500 Index Historical Earnings Revisions graph for June 30, 2008–September 30, 2022

Past performance is not a reliable indicator of future performance. Actual outcomes may differ materially from estimates.
Sources: S&P Global Market Intelligence, S&P Capital IQ Estimates, FactSet.
*EPS is earnings per share.

In this quarter’s note, we frame potential negative earnings revisions using the “outside view.” Our integrated investment approach combines the “inside view” (bottom-up knowledge of individual companies and current market conditions) with the outside view (probability of what is most likely to happen given historical precedents of similar situations). In this particular situation, the outside view is what has historically happened to earnings estimates during typical years. This needs to be paired with the inside view, which is today’s unusual macro environment featuring high inflation, supply chain dislocations, historical stimulus followed by Fed tightening, margin risk, and geopolitical tensions. One particular concern is margins, which have risen for 25 years through declining costs of goods sold; lower interest rates; muted labor costs in selling, general, and administrative expenses; and declining taxes. All four margin tailwinds are likely to be headwinds looking forward, although inflation will be an offset to nominal sales and earnings. In aggregate, we find the outside view instructive, and the inside view suggests this earnings drawdown could be somewhat worse than historical precedents.

Average Estimate Revision—15 Months Prior to Each Fiscal Year-End

(Fig. 6) June 30, 2008–December 31, 2021

Average Estimate Revision—15 Months Prior to Each Fiscal Year-End graph for June 30, 2008–December 31, 2021

Past performance is not a reliable indicator of future performance. Actual outcomes may differ materially from estimates.
Sources: S&P Global Market Intelligence, S&P Capital IQ Estimates, FactSet. S&P Capital IQ Consensus Estimates represent the aggregation of individual estimatesprovided by sell-side analysts that are covering a public company.

Considering the last 15 years, we can frame likely earnings declines in the “average” year (independent of any recession forecast). Every year, as shown in Figure 5, sell-side analysts forecast year-end earnings for the 24 months leading up to year-end; for example, analysts will forecast 2023 earnings throughout the years 2022 and 2023.

We highlight three main observations:

  • In most years, analysts start overly optimistic, but they lower their estimates as reality sets in (i.e., the outside view is that sell-side estimates for a given year-end should decline)
  • These declines were most precipitous heading into recessions (e.g., 2008, 2020)
  • The uncommon increases typically occurred as the economy emerged from recession (2009, 2021)

Using this outside view approach, we can calculate the average earnings decline over the 15 months prior to each year-end (i.e., the remaining period for 2023). For this analysis, we include both normal and recessionary periods to reflect the range of potential outcomes without making a call on recession probability, but we remove the years with positive revisions (as it’s not plausible that the economy is emerging from recession right now).

As expected, defensive sectors’ earnings held up well (health care, utilities, and consumer staples) while cyclical sectors declined the most (energy, materials, industrials, financials, and consumer discretionary). However, we realize no two periods are perfect comparisons and next year will have its own nuances. For example, it is likely that tech earnings will prove to be more cyclical than they were over the past decade, while energy may no longer be cyclical amid a decade-long bear market. The value of this model is to apply the outside view as a base rate and then apply the inside view on where those key differences may arise.

Current and Adjusted P/E Ratios

(Fig. 7) As of September 30, 2022

Current and Adjusted P/E Ratios graph as of September 30, 2022

Past performance is not a reliable indicator of future performance. Actual future outcomes may differ materially from estimates shown.
Sources: S&P Global Market Intelligence, S&P Capital IQ Estimates, FactSet.
*P/E current is the current price over consensus earnings estimates for 2023.
† P/E adjusted for typical revisions is the current price over earnings estimates for 2023, adjusted for estimate revisions illustrated in Figure 6 and assuming the weights of the sectors in the S&P 500 as of September 30, 2022, for the index adjusted P/E.

Using this framework, we can look at each sector’s valuation using both current and adjusted 2023 earnings estimates. Figure 7 illustrates how the S&P 500 and sector price-to-earnings (P/E) ratios could change—the defensive sectors’ P/E ratios stay relatively constant as earnings hold up, while the cyclical sectors become more expensive as earnings decline. Figure 8 shows relative P/E ratios compared with the market (S&P 500)—for example, while utilities currently look 19% more expensive than the market, after accounting for their earnings stability they may only be 6% more expensive.

Current and Adjusted P/E Ratios—Relative to the S&P 500 Index

(Fig. 8) Discount or premium to the market, as of September 30, 2022

Current and Adjusted P/E Ratios—Relative to the S&P 500 Index graph showing discount or premium to the market, as of September 30, 2022

Past performance is not a reliable indicator of future performance. Actual future outcomes may differ materially from estimates shown.
Sources: S&P Global Market Intelligence, S&P Capital IQ Estimates, FactSet.
Please see Figure 7 for the details on the P/Es used for the analysis. This analysis compares the current and adjusted P/E ratios for each sector, shown in Figure 7, as a multiple of the respective P/E ratio for the S&P 500 Index, also shown in Figure 7.
*Historical premium (discount) is based on historical earnings revision data from June 30, 2008-September 30, 2022.

What does this imply about current market valuations? As shown in Figure 7, the S&P 500 multiple would rise from 14.8 to 17.0 based on estimated earnings declines using solely the outside view. When incorporating our inside view reflecting macro headwinds, we believe earnings risk is to the downside. Furthermore, multiples often overshoot on the downside entering recessions until there is more visibility on the earnings floor. While we don’t forecast price levels for the market, our outside view suggests S&P 500 earnings for 2023 could fall from $241 to $210 per share.

S&P 500 2023 Earnings Expectations vs. Implied P/E

(Fig. 9) Earnings and implied P/E for various levels of earnings change

S&P 500 2023 Earnings Expectations vs. Implied P/E for various levels of earnings change

Sources: S&P Global Market Intelligence, S&P Capital IQ Estimates, FactSet, T. Rowe Price analysis. Actual outcomes may differ materially.
*EPS is earnings per share.
Figure 9 shows potential EPS levels and implied P/E ratios for a variety of hypothetical EPS changes, assuming today’s current market price.
The two highlighted bars are 0.00% (corresponding to no change in earnings) and -12.92% (corresponding to the outside view from Figure 6).

Despite these concerns, there are always attractive opportunities in the market. Right now we are focused on reasonably priced defensive stocks (e.g., we prefer defense and health care to utilities and staples), along with cyclical stocks that we believe are already pricing in an earnings recession.

Appendix

Factors are our internally constructed metrics defined as follows:

Valuation: Proprietary composite of valuation metrics based on earnings, sales, book value, and dividends. Specific value factor weighting may vary by region and sector.

Growth: Proprietary composite of growth metrics based on historical and forward-looking earnings and sales growth. Factor selection and weighting vary by region and industry.

Momentum: Proprietary measure of medium-term price momentum.

Quality: Proprietary measure of quality based on fundamental and stock price stability, balance sheet strength, various measures of profitability, capital usage, and earnings quality.

Profitability: Return on equity.

Risk: Proprietary composite capturing stock return stability over multiple time horizons (positive return means risky stocks outperform stable stocks).

Size: Market capitalization (positive return means larger stocks outperform smaller stocks).

Short Interest: Total number of shares of a security that investors have sold short divided by the float-adjusted shares outstanding as of a given date.

Additional Disclosures

Copyright © 2022, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

© 2022 Refinitiv. All rights reserved.

London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2022. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.

Source: MSCI. MSCI and its affiliates and third party sources and providers (collectively, “MSCI”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Historical MSCI data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

IMPORTANT INFORMATION

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass.

The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

USA – Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

© 2022 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

Previous Article

October 2022 / U.S. FIXED INCOME

Inflationary Forces Set to Overpower Disinflationary Trends
Next Article

October 2022 / GLOBAL ECONOMY

The Storm in Financial Markets Is Not Over Yet
202209-2452396

You are now leaving the T. Rowe Price website

T. Rowe Price is not responsible for the content of third party websites, including any performance data contained within them. Past performance is not a reliable indicator of future performance.