Earnings season to test growth vs. value stocks strategy

This is a big week for earnings, and the market will be focused on the results from Goldman Sachs, Morgan Stanley, Proctor & Gamble, United Airlines and Netflix to name just a few. This week’s earnings could be an important test of the popular strategy in stock markets to sell the tech sector, or growth stocks, and buy the cyclical sector, or value stocks. Earnings season will be a key test to see if this strategy is working, and whether cyclical companies really are outperforming their peers in the tech world. Elsewhere, some key economic data is also released this week including UK CPI, and the dovish end of the central banker spectrum will be in focus with minutes from the ECB and a Bank of Japan meeting on Tuesday. 

Cyclicals are expected to shine 

S&P 500 companies are expected to report earnings growth of 20% year on year for 2021, however, there is a greater disparity than normal because of the underperformance of one key sector: tech. For example, the S&P 500’s tech sector is expected to report earnings growth of 11%, while the consumer discretionary (excluding online sales) is expected to see growth of 30%, the materials sector is expected to see 60% growth and industrials are also expected to post earnings growth of more than 50% for last year. Thus, although 11% earnings growth for the tech sector is a decent increase, there are better gains to be had elsewhere, which is why we still like the value vs. growth story as we move into Q1. 

Resilience to inflation pressures are key 

A key value sector, financials, did not get off to a good start when some of their biggest names reported earnings last week. Although JP Morgan beat earnings estimates, its shares were down more than 6% on Friday. Citigroup, a US banking stock that we think will outperform its peers this quarter, was also lower, however, it was only down by 1.25%. Investors did not like JP Morgan’s earnings forecasts for Q1 2022 and beyond. Wage growth and a higher cost base was among some of the key concerns. We think that JP Morgan highlights a key theme for investors this earnings season: inflation. US CPI rose to a 7% annual rate last month, which is the highest level for nearly 40 years. As we have mentioned, those companies that can withstand inflation and supply chain woes will be rewarded, those that can’t will be sold off, and sharply in the case of JP Morgan. This is why we like the airline sector in the US and Europe right now. Firstly, annual comparisons for 2021 earnings vs. 2020 will be favourable, and although the airlines are impacted by inflation, most notably jet fuel costs with the average gallon of jet fuel up 11% in Q4 vs. Q3 2021, we think that the uptick in leisure travel in the west this year will be enough to counter-balance these concerns. Hence why we think that traders should watch out for United Airlines’ earnings report on Wednesday 18th after the US market closes. 

BOJ and UK CPI to drive FX flows 

In the FX space, UK inflation for December and the BOJ meeting are the big events to watch this week. The BOJ meeting on Tuesday is not expected to see policy change, however, it could be a more interesting BOJ meeting than we are used to. Inflation has started to creep higher, with rising wholesale prices, which raises the risk that the BOJ could change its outlook from price pressures being skewed to the downside to a more balanced outlook for price pressures, highlighting the fact that Japan is not immune to the global inflationary impulse. USD/JPY saw a steep sell off on Thursday and Friday, however, this pair managed to claw back some earlier losses at the start of the week even though US stock markets were closed. Any shift in the BOJ’s stance to a more ‘hawkish’ view of inflation could be met with another surge higher in the yen, sending USD/JPY back to the 113.50 low from Friday. 

GBP/USD has backed away from $1.3750, the high from last Thursday. UK CPI is scheduled for release on Wednesday and is expected to show that the annual rate of CPI rose to 5.2% in December, which would be the highest level since October 2011. There is a risk that inflation could dip slightly due to a fall in the price of clothing and footwear, however, food prices are expected to have risen strongly last month. Along with labour market data, which is expected to tighten for yet another month, we think that this will lead to an increase in the probability of another rate hike from the BOE when they meet on 3rd February. A speech from Andrew Bailey at 1415 GMT on Wednesday could also shed light on whether the BOE will adopt a more aggressive approach to rate rises and hike at each meeting for the foreseeable future until inflation returns to more acceptable levels. We think that GBP/USD could be hamstrung around the $1.3650 mark, so we prefer EUR/GBP, which has been range-bound since the start of this year around 0.8350, a long-term support level. A drop below this key support zone could open the way to a 6-year low at 0.8000. However, for such a major support break, we think that the ECB will have to maintain their strict adherence to the “temporary” inflation phenomenon, and for the BOE to take an aggressively hawkish stance and hint that rates will rise at every meeting. If that happens then a break lower for EUR/GBP is likely, if not then we could remain range bound in this pair for the medium term. 

The link between crypto and tech 

The broad crypto space is lower on Monday, with Bitcoin down more than 3% at the time of writing. The drop in crypto is mirroring the sell-off in tech, however, the sell-off in crypto is of a far greater magnitude than the sell-off in tech. Thus, if we see tech stocks fail to deliver this earnings season, we may see more pain for crypto.