DON'T GET TOO EXCITED ABOUT THE LATEST QUARTERLY REPORTS
Inflationary pressures a concern while energy worth a look, Martin Pelletier says.
There is, no doubt, a lot for investors to get excited about if they're looking at the most recent earnings reports. Nearly 65 per cent of companies in the United States had reported third-quarter results as of Monday, and, so far, earnings are tracking to post a 40-per-cent gain over the same quarter last year, according to a Refinitiv analysis, and more than 80 per cent of companies have beaten analyst expectations.
Closer to home, earnings by S&P/TSX composite companies have also hit new all-time highs and are well above their pre-pandemic levels. Strong reports came in across multiple sectors, with a notable exception being consumer staples, where three-quarters of those reported missed analyst expectations.
However, we wonder how much of this good news is already factored into share prices.
We calculate that the S&P 500 and S&P/TSX composite are both up nearly seven per cent since earnings started rolling in. The top-performing sectors in Canada so far this year include energy, up nearly 48 per cent, followed by real estate (30 per cent) and financials (27 per cent). The worst-performing sectors are health care, down eight per cent, followed by materials, down nearly two per cent, even though their results were not bad.
Looking at forward guidance, we worry about the impact of the inflationary pressures that appear to be taking root. This could prove to be more permanent than transitory in nature, as government officials would have us believe.
For example, Amazon.com Inc.'s year-over-year revenue growth in its most recent quarter came in at 15 per cent, which is down from 37 per cent in the same period last year. But, more importantly, the online behemoth highlighted that supply chain challenges are becoming a problem, including rising freight and shipping costs, along with labour shortages and higher employee costs.
Amazon's woes are reflective of a broader trend and some of these higher costs will have to be passed along to the consumer, otherwise margin compression could impact forward earnings. As this trend accelerates, central banks will be challenged to raise interest rates, especially in Canada where households face record debt levels along with record-setting deficits among municipal, provincial and federal governments.
More so, Canadian residential investment has now reached nearly 10.5 per cent of our gross domestic product, which is more than four standard deviations away from our long-term average. It is, therefore, worth keeping a close eye on the Canadian banking sector's exposure to this, because a recent Moody's report indicates it could be vulnerable to economic shocks due to a decline in government-backed mortgage insurance.
The report indicated that insured residential mortgages only made up 26 per cent of total mortgage exposures at the end of the second quarter this year, which is down from 47 per cent five years ago.
That said, we think the housing market could still take time to play out since politicians and bankers will do whatever steps are necessary to prevent a bursting of the bubble. In the interim, there could be incremental upside from dividend hikes by the banks, especially following the relaxed rules announced last week by the Office of the Superintendent of Financial Institutions.
Canada's six largest banks could return a combined $47 billion (US$38 billion) in cash to shareholders and still exceed regulators' capital requirements, according to an analysis by Bloomberg Intelligence.
We also really like energy for both its near- and longer-term upside when it comes to further growth from dividends and/or share buybacks, despite some already strong moves in share prices.
Suncor Energy Inc.'s recent massive dividend hike is telling of the entire sector, as it has collectively decided to distribute its piles of free cash flow from high oil and natural gas prices to investors instead of putting it back into the ground. This capital discipline and robust demand versus weak supply fundamentals are why we're the most excited we've been in more than a decade about the sector.
As you can see, it is helpful to move beyond the headlines when reviewing quarterly reports and drill deeper into ongoing industry trends, then reposition your portfolio accordingly. In today's environment, this is very important given some of the impactful trends that are emerging.
Financial Post
Martin Pelletier, CFA, is a portfolio manager at Wellington-altus Private Counsel Inc, operating as Trivest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.