Reasons to be cheerful

The discovery of the Omicron variant had a dampening effect on the Thanksgiving holiday weekend, and the reaction of the US market last Friday suggests that it was not only the copious amounts of turkey and pumpkin pie that gave American investors indigestion. The WHO announced that it may take weeks before the transmissibility and lethality of this new strain is determined, however governments, having been slow to react to the initial outbreak, as well as the Delta variant, seem to have adopted an approach of firing first and asking questions later.

As the rate of hospitalisations is yet to be evaluated, there is a chance that it is more like a common flu for those who are fully vaccinated; if this proves to be the case investors can re-focus on the global economy. While supply side constraints, inflation, and bottlenecks have been on the minds of company management teams and investors alike, we noticed that many companies reported record levels of demand in the recent reporting season, suggesting that it is as much as a magnitude of demand problem as a supply problem, and believe this is an encouraging sign for the coming quarters, especially as it gives management teams greater visibility of orders going forward.

With 2022 forecasts now being moderated, we believe that there is headroom for companies to positively surprise should this excess demand persist. The chart above shows a sharp improvement in Federal Reserve’s expectations and reading of economic sentiment, fully recovering from the raw material inflation led declines over the summer.

The OECD’s readings of business confidence show a similarly upbeat picture, with many regions recording all-time high levels. The chart below shows The EU recording a level well in excess of previous highs and the G7 aggregate is also making new highs. THE OECD aggregate also shows a similar trait, and while the US data is rising, it is yet to surpass the highs seen in the early 1980s. The survey considers opinions on the developments in production, orders and stocks of finished goods, so to see a plethora of regions recording readings well above 100 bodes well for future economic activity and company profits.

In line with confidence improving, the Conference Board’s index of 10 economic indicators also has reached all-time highs and is well above the pre-pandemic levels. The index is regarded as a good predictor of turning points in the economy, and thus far it is suggesting that 2022 will see the economic expansion seen in 2021 continue and possibly gain momentum. Both the Lagging and Coincident indices from the Conference Board also posted gains in October, but the Leading index is the key measure, as the value of a company is the present value of its future cash flows, so future growth in the economy is essential for current valuations to be supported.

This confidence is backed up by the strength of new orders, which continue to make new highs and is also normally a good indicator of future growth. Similar, to the US chart below, the UK’s equivalent CBI new order balance stands at the highest levels since the survey began in April 1977, and export orders balance are back to early 2019 levels.

While the value of new orders could be in part down to raw material inflation, the chart below shows that while the most responders are reporting high input costs, the situation appears not to be getting any worse and thus the chart above really is suggesting a strong 2022 for capital goods manufacturers.

With the many of the macro-economic surveys looking so strong, and initial jobless claims falling to their lowest level since 1969, it really does appear that there are reasons to be cheerful. Although we do not expect a universally strong set of numbers going forward, especially given lockdowns in Europe and China adopting a zero COVID policy, it appears that the tide has turned, and we may now be past peak stress. Although slightly backward looking, as it purports to the past quarter, corporate profitability as a percentage of GDP stands at the highest level since 1969, and on a post-tax basis, since World War 2, despite all the raw material inflation.