News

Prof. Dr. Jan Viebig Global Co-CIO ODDO BHF

A number of good reasons would have justified a less favourable reporting season in the US over the first quarter of 2024. At 1.6% (annualised compared to the previous quarter), economic growth in the winter quarter was significantly lower than in previous quarters, while inflation, measured for example by the personal consumption expenditure (PCE) deflator, accelerated to 3.4% (also annualised compared to the previous quarter). Labour costs continued to rise sharply, which could have had a negative impact on margins. In addition, longer-term yields have risen noticeably in view of significantly more cautious expectations of interest rate cuts. The Fed is likely to leave its key interest rates higher for longer than was thought a few months ago. The global environment also remains difficult: the IMF recently described the recovery process as "steady but slow". 

And yet: US companies' reports for the first quarter of 2024 once again came as a positive surprise. As things stand, the reported earnings of companies in the broad market S&P 500 index have significantly exceeded analysts' expectations for the first quarter of 2024, mainly due to the widening of the profit margin. If the profits of all S&P 500 stocks are added together, this results in total profits of USD 425 billion. Analysts had expected 393 billion dollars. Admittedly: Exceeding expectations is more the rule on Wall Street - thanks to clever expectation management and a skilful accounting policy. However, with an increase of 8 per cent, the volume in the first quarter clearly exceeds the usual level.

If the trend is confirmed - more than 90 per cent of companies in the S&P 500 have now reported - earnings growth in the first quarter could be a good 5 per cent, significantly better than estimated just a few months ago. The start to 2024 is therefore developing very promisingly, as the growth rates in the coming quarters are expected to be even higher according to analysts' estimates.

The markets have reacted correspondingly favourably to the good figures from the reporting season, which is now slowly drawing to a close. After the price declines in April, May is presenting itself with momentum. The performance for the full year 2024 has improved from 6.0 per cent at the end of April to currently 10 per cent within a few days (as at 13 May 2024).  

Most investors are likely to be pleased with this development. At the same time, however, there is growing concern that the "party" could come to an unpleasant end. An old stock market saying is doing the rounds: "Sell in May and go away" - take your profits and run. 

We doubt that this is good advice. Of course there is a risk of a setback, and perhaps the risk is even somewhat greater than normal at the moment. Investors on Wall Street are quite willing to hand out advance praise and valuations have risen sharply, especially in the US. The price/earnings ratio (P/E ratio) for the S&P 500, which puts the share prices of all companies listed in the index in relation to earnings per share, has climbed to over 21 in the first few months of this year - based on earnings estimates for the next 12 months. If you look at the actual profits of the last 12 months, the P/E ratio is even higher than 23, which is a sporting order of magnitude that definitely calls for caution. For a long-term investor, however, the decisive question should be: Are the high share prices justified by the expected earnings growth? 

The answer to this question must be differentiated. Firstly, as long-term investors, we have a different perspective on the recurring ups and downs of the stock market. We are convinced that investors should remain permanently invested in the stock market in line with their risk appetite. Trying too hard to find the right position at the right time is likely to do more harm than good, as small mistakes in timing can have a major impact on investment success. Even in the long term, a few good (or bad) days often make a decisive contribution to investment success. We are convinced that trying to predict these days reliably is not a serious endeavour (see Fig. 1).

Figure 1: Performance of a USD 10,000 investment in the MSCI World Total Return over 20 years depending on the number of best missed trading days

Past performance, simulations or forecasts are not a reliable indicator for the future. Returns may rise or fall as a result of currency fluctuations.
Source: Bloomberg, period 12.04.2004-12.04.2024

Furthermore, one should not be frightened by reports of all-time highs. The fact that a market is at or close to a new all-time high says little about long-term investment success. Price history shows that there are many months with new all-time highs. The MSCI World, for example, has closed at a new all-time high for a total of 150 months (out of 532 months) over the last almost 55 years. Long series of new highs were not uncommon either. Investing at an all-time high does not, as far as can be deduced from the past, lead to significantly worse investment results for long-term investors than at other times. 

Figure 2: Performance of the MSCI World Total Return Index since the end of 1969 and all-time highs over time, on a monthly basis2 : 



Past performance, simulations or forecasts are not a reliable indicator for the future. Returns may rise or fall as a result of currency fluctuations.

Source: Datastream, period: 31.12.1969-31.01.2024

High valuation levels are somewhat different. A high price-to-book ratio of the market or a high price-to-earnings ratio (especially in the cyclically adjusted version of Shiller) tend to correspond with weaker long-term investment results, as can be shown empirically. 

However, we generally do not invest in equity markets and indices, but in selected equities. The selection of equities is at the centre of our investment concept. We specifically look for companies with high earning power that should benefit from important long-term growth trends. These companies must also be "appropriately" valued in order for us to consider them. However, "reasonable" does not exclude the possibility that some of these shares are more expensive than the market average - measured by the P/E ratio, for example. The higher price may be justified by future earnings momentum. P/E ratios take into account the current earnings situation (actual or expected), but cannot reflect the longer-term dynamics of earnings.

We therefore examine whether the valuation is still "appropriate" on a case-by-case basis rather than across the board. In the current environment, technology stocks in particular are valued at above-average levels. As the weighting of the so-called "Magnificent Seven" in the index has risen continuously, for example, they are largely responsible for the share price performance. However, it is also the technology stocks in particular that have far above-average earnings power and momentum. The free cash flow - a measure of profitability that is largely independent of accounting leeway - of the S&P 500 companies has risen by a factor of 2.5 in recent years. The "Magnificent Seven", Microsoft, Apple, Amazon, Meta, Nvidia, Tesla and Alphabet, have clearly dominated events. Their free cash flow has increased by a factor of 4.5 in the same period. 

The current reporting season confirms this trend. Only the semiconductor manufacturer Nvidia has not yet presented any figures. The report has been announced for 22 May 2024. For the others, they have been mostly good. Amazon and Microsoft in particular were able to significantly increase sales and profits in the first quarter. Meta also published good quarterly figures, but the market reacted somewhat "huffily" to the announcement of high capital expenditure - particularly in the area of artificial intelligence.

We are convinced that trends such as artificial intelligence will have a major impact on the stock markets in the coming years. However, the example of Meta also shows that the conversion of the business model to the new technologies does not come for free and in some cases will tie up a lot of the capital available to companies.

Although the US equity markets are trading close to historic highs and although the valuations of US equities have risen sharply, the annual reports for the first quarter show that attractively valued stocks with high earnings growth can still be found on Wall Street. However, the results also show that it is not enough to bet on this. Long-term investors need to identify the strong trends and take a close look at the question of which companies will benefit directly from them and which will be negatively affected by them.

Disclaimer

This document has been prepared by ODDO BHF for information purposes only. It does not create any obligations on the part of ODDO BHF. The opinions expressed in this document correspond to the market expectations of ODDO BHF at the time of publication. They may change according to market conditions and ODDO BHF cannot be held contractually responsible for them. Any references to single stocks have been included for illustrative purposes only. Before investing in any asset class, it is strongly recommended that potential investors make detailed enquiries about the risks to which these asset classes are exposed, in particular the risk of capital loss. 

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