Where do we go from here? February saw a repricing of US bond market interest rate expectations, management teams holding their cards close to their chest, and the emergence of a more dollar conscious consumer. According to Jeremy Richardson, investors should be focusing on the creation of value, and strong company fundamentals that drive long term share price performance.
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Hello this is Jeremy Richardson from the RBC Global Equity team here with another update. Now, February's been an interesting month that started strongly. Chairman of the US Federal Reserve told the world that in his opinion, the US market was heading into a disinflationary period. That should be good news for investors because the fears of inflation have kept interest rate expectations high for quite some period of time.
But the month didn't end that way. Continued strong momentum from economic data, coupled with tight labour markets and particularly stubborn core inflation data, has meant that the US bond market has repriced its expectation of the peak of US interest rates, adding an additional 50 basis points to the terminal rate, now way above 5% and much more consistent with the Federal Reserve's own expectations.
Now, for equity investors, that has been a bit of a valuation headwind for the asset class, and we have seen some give back in February compared to the levels that we started the beginning of the month with. And it's probably fair to say that the end of the earnings season probably hasn't helped too much either. Now it's always a bit of a game trying to second guess who's going to beat expectations. And most companies, believe it or not, do end up beating expectations, approximately about three quarters of them on average.
However, this earnings season, that proportion has been around about two thirds, so less than what we've historically seen. And in addition, the forward-looking comments from management teams, the guidance, has also been a bit softer. And I think we can probably understand the reasons why; there's a lot of uncertainty in the world and it would be a very brave, bold management team who come out with some very positive, forward-looking statements. So, it's completely understandable that management teams are holding their cards close to their chest, trying to give themselves a little bit of space to manage the situation as the year progresses. But in the short term at least, it's removing perhaps some of the potential positive catalysts that we might have been hoping for to really offset the valuation headwinds that we've seen from rising discount rates.
One thing that is probably worth just mentioning, and I would highlight one company if I may, we've had a large vendor of pizzas, Dominos pizzas. We've had some results very recently, a couple of weeks ago, and I thought that was a really interesting set of results because in my view it sort of encapsulated a much bigger debate around pricing and costs. The company, the results disappointed the market somewhat, but what they remarked upon in particular was that consumers are beginning to change their behaviours. They are becoming more dollar conscious. They are noticing that prices are rising. They’ve become a little more resistant to accepting price increases and at the margin, willing to get in the cars and drive to pick up the pizza rather than pay the extra delivery charges too. So, a more dollar cost conscious customer is beginning to emerge.
And that's making it harder generally for companies to be able to increase prices. We are beginning now to see some crashes and push back from the market in terms of higher prices, and that's a concern for companies when cost pressures are still with us. Yes, we may have a little bit of disinflation because commodity prices are falling and thankfully energy costs were what they are. However, we are still seeing wage increases, and so this is putting some pressure on margins. That may be one of the reasons why management teams are so cautious in terms of the forward-looking guidance.
Where do we go from here? Well, we're coming to the end of the earnings season. The die is cast now, I think for the next quarter. Generally, though, I would say that my sense is that this continues to be part of generally an improving situation. And the reason why I say that is because nobody expected inflation to fall in a linear and consistent kind of manner. There will be ups and downs and I think the market is naturally reacting to that. However, with the general pattern of progress continues to be in a more supportive direction, I would say, where we end up with hopefully at the end of this process, lower levels of inflation, maybe even lower levels of interest rates at a much more sort of benign environment, I would say for companies to really focus on the day job, which should be the creation of value and the strong company fundamentals that drive long term share price performance. And for fundamental, bottom-up, active investors like ourselves, that's a future that we can very much believe in.
I hope that's been of interest and I look forward to catching up with you again soon.