Global Conflict Depresses Short-Term Outlook, But Clouds May Be Parting

Written By Chris Odeh, Director & Steve Adams, Managing Director, Chief of Staff

March 30, 2022

The now-wrapped Q4 2021 earnings season was marked by outperformance to close the calendar year, but real concerns as analysts look to 2022. Most companies (77% to be exact) beat their EPS guidance. However, Q1 2022 outlooks are down across almost all sectors in response to geopolitical risks, inflation concerns, contractionary federal reserve policies, and skyrocketing petroleum prices, which dampen consumer spending.

Record Highs Meet Record Lows

December of 2021 brought near-all-time highs for the S&P 500 as promising signs of Omicron decline led to cross-sector equities rallies. This, paired with the seasonal “Santa Claus rally,” brought about several record-closes in the final month of the calendar year.

Fast forward to mid-March of 2022, and the S&P dropped more than 12%.

Given that much of the bearish response in the market is in reaction to international conflict, the duration of the ongoing downward trends is difficult to predict. Analyst projections for 2022 S&P 500 earnings growth are now below 8% despite exceeding 9% at the close of 2021. This is a clear signal that analysts expect current headwinds to either A) last long enough or B) provide enough impact to throw the full calendar year off course.

Energy Thrives While Others Fall

Since the Russian invasion of Ukraine, beginning on February 24th, and subsequent sanctions on Russia, markets have responded fiercely. Energy prices (petroleum, in particular) have soared with WTI crude peaking near $130 per barrel, representing the highest levels since June of 2008. As a result, the energy sector is posting a significant increase in estimated earnings for Q1 2022 of nearly 15%.

Outside of the energy sector, however, all other sectors have seen declining share prices on the whole. Cyclical sectors like consumer discretionary have experienced the largest declines in estimated Q1 earnings, dropping 7.6% compared to expectations at the start of the year.

Interestingly, the S&P 500 is largely unexposed to Russia in terms of revenue. Just 1% of annual sales across the index are generated in Russia, and even the most exposed companies are not facing significant revenue risk. Philip Morris International tops the S&P 500 in this area, with 8% of revenue coming from Russia; all other index constituents collect less than 5% of sales from Russia.

Although most major American corporations don’t have revenue exposure in Russia, supply chain exposure is a different issue. Oil and gas are well-known exports of Russia—both of which have led to the aforementioned abnormalities in the energy sector. But Russia and Ukraine are also large exporters of other key products. Russia is the world’s largest exporter of palladium and the second largest exporter of platinum—both of which are used in autocatalytic converters. Ukraine supplies key wiring harnesses for auto manufacturers around the world. The two countries combined produce nearly half of the world’s neon gas used for semiconductor production. And Ukraine produces 15% of the world’s corn supply, while Russia supports roughly 13% of the world’s fertilizer production.

So, although many companies are keen to highlight their lack of revenue exposure to Ukraine and Russia, the truth is global supply chain disruptions will have a much more significant impact on financial performance across many sectors.

It’s Not All Bad

Despite the ongoing conflict in Ukraine and elevated petroleum and gasoline prices, some things are trending in the right direction. The Federal Reserve announced on Wednesday, March 16th, that it would raise interest rates for the first time in three years. This move quells many concerns about current inflation rates and led to an afternoon rally among the S&P 500, which closed up 2.5% on the day.

Although valuations were (and, in some cases, still are) suppressed, fundamentals are still intact. Strong corporate share repurchases, consumer balance sheet strength, economic normalization, and now-upward trending earnings estimates are all bright spots in challenging times.

Update Your Narrative Accordingly

Key market participants will watch closely as the geopolitical situation materializes over the coming months, while also focusing on the domestic impact of hawkish monetary policy and waning fiscal stimulus. Investor relations officers and other corporate leaders should correspondingly focus on the strength of their balance sheets, favorable capital allocation policies, resilient free cash flow generation, and a protected supply chain. If you’d like help in crafting a nuanced investor narrative in a particularly volatile period, give us a call.

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