- Beware earnings forecasts underplaying recession risk
- Weak impetus across the board a reality check to relative momentum
Momentum investing can get badly caught out when market regimes change and the economy shifts into a new cycle. The two things don’t happen perfectly in step of course, the stock market is typically a lead indicator. Our earnings upgrade screen should in theory bridge the gap - analysts’ expectations of real world profits ought to inform the prices paid for shares today. The trouble is, consensus on macro-economic outlooks can sour rapidly and earnings forecast momentum can reverse like price momentum.
Banks and financial stocks again do well this month, but there is the nagging doubt that recession risk is under-priced. Banks will do better in a rising interest rate environment with the back-drop of a relatively soft landing for the economy as policy decisions to rein in inflation bite. But if there is a recession the potential for greater loan impairments can counteract that.
Utilities shares traditionally have defensive properties and Centrica (CNA) scores well on earnings forecast momentum. However, the share price has moved sideways for the last couple of months and much of the expected profits growth seems to have been priced in then.
Revealingly, some companies with quite negative share price momentum are passing our tests because although they’ve declined in value, that fall has been less bad than the median share price fall for stocks in the index over the period.
In the case of some companies with high quality earnings, share price falls are partly due to the ongoing adjustment to valuations in response to higher inflation and interest rate rises. In short, these markets aren’t conducive to blindly following momentum as there are simply too many changes afoot.
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