Global mid-cap equity valuations de-rated significantly over the past 12 months amidst a sharp rise in inflation and the surge in cost of capital hurdle. The MSCI World Mid Cap index’s valuation fell to a decade-low level of 14 times price-to-earnings.
Notwithstanding the valuation pressure seen in late 2022, the IT sector stood out, generally delivering strong earnings and optimistic outlooks. This reflects the potential for structural growth in this sector, largely due to global themes that persist in our daily lives and the corporate world – data centres and the cloud; networks and connectivity enablers; software to create productivity or critical information management; artificial intelligence and content platforms. Consequently, technology was the best-performing sector.
Industrial stocks were also strong performers over the period, delivering the second highest return given positive earnings in construction and engineering services; robust passenger airlines demand and solid related travel activity. Within this sector, strong employment growth and corporate spending activity lifted commercial services.
Consumer strength in the luxury goods segment was supported by confidence from the wealthier pockets of the world, which was unusual as the rest struggled with a cost-of-living crisis.
Insurance was a beneficiary of a hardening rate cycle, lower capital in the financial system and higher returns on capital investments.
Other sectors such as real estate, utilities, energy and healthcare were all in the red. The Silicon Valley Bank collapse in March 2023 stoked financial system concerns and led to conservative funding across the market. This has set a cautious tone as exuberance and momentum fade and are replaced by the harsh reality of a nervous investor seeking earnings, yield, certainty, and visibility.
Earnings, earnings, earnings
‘If you can follow only one bit of data, follow the earnings … What the stock price does today, tomorrow, or next week is only a distraction.’ — Peter Lynch
We’ve had cheap money for nearly 10 years and allowed for stories and concepts to be generously valued independent of earnings. With inflation at 6% and government bond yields at 4%, earnings will be a significant driver of share prices during the next 12 months. The drivers of sustainability of
earnings will also be important considerations such as pricing power, market structures, embedded purpose of the product for people or corporate processes, and the critical or discretionary nature for consumers.
As the risk of recession or economic slowdown transcend across the economy, these considerations will become top of mind for investors and determine valuations that the market will bear. This market will test our understanding of investments and conviction in management to navigate a challenging economic environment. Stock picking will be critical.
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