If you think it’s just FTSE AIM where sentiment is collapsing, think again. Alphabet, Barclays and easyJet are all falling — and the only thing they have in common is strong fundamentals and weak sentiment.
As your resident small cap analyst here at Investing Strategy, it may seem that most of my work is occupied by FTSE AIM shenanigans. Of course, I do enjoy high risk, high reward investing — but in reality, most of my time is spent covering blue chip stocks for multi-billion dollar enterprises.
This whole-of-market view gives me a more rounded perspective of wider macroeconomic issues.
Of course, one of the big problems in the small cap market right now is that sentiment is at rock bottom. I’ve previously argued that the index has fallen close to its pandemic crash low because of the impact of higher rates on the equity risk premium, but something I didn’t mention is that weak equities sentiment isn’t just confined to the small caps.
The FTSE 100 is down 2.2% year-to-date. The ASX 200 is down 1.3%. Excluding the ‘magnificent seven,’ the S&P 500 is also slightly down this year. These seven tech shares have returned circa 90% in 2023 after a terrible 2022 — but this overreliance on one sector boosted by the AI bubble is perhaps not healthy.
The problem is that bonds are now delivering relatively healthy returns — 10 year US Treasury yields are at 5% and this completely risk-free return is causing some consternation up high too. There are plenty of examples of what’s going on in this earnings season, but I’ve selected three which operate in completely different sectors to emphasise my key point:
Blue chip earnings season
Alphabet shares fell by 6.7% in after-market trading yesterday, but with a cursory glance this might be surprising:
- Q3 revenue rose by 11.6% year-over-year to $76.69 billion, above analyst predictions of $75.9 billion
- Q3 advertising revenue was $7.95 billion, compared to estimates of $7.81 billion
However, the Cloud division only managed to generate $8.41 billion compared to expectations for $8.64 billion — and this was apparently the cause of the sizeable market cap fall. For context, the division only started turning a profit in Q1 and has been running since 2008.
CEO Sundar Pichai even tried to highlight AI as though the bubble could save him — ‘we’re continuing to focus on making AI more helpful for everyone; there’s exciting progress and lots more to come.’
However, Alphabet is also facing a landmark antitrust lawsuit from the US government and is firing thousands of employees as well as reducing perks.
Barclays shares also fell by 6.5% yesterday, after reporting what at a first scan looks like relatively positive results:
- Q3 pre-tax profit came in at £1.89 billion, down from the previous year’s £1.97 billion but slightly above analyst expectations
- Q3 EPS was 8.3p, well above the 7.4p consensus prediction
- UK Net Interest Margins for 2023 are now predicted by the bank to be between 3.05% and 3.10%, down from 3.15%
Investors beat analyst expectations, and yet shares fell. There are a few reasons for this — to start with, banks enjoy an interest rate sweet spot of between 3-4% — lower than this and profits fall, higher than this, and impairment charges start to weigh on sentiment.
Indeed, Barclays set aside £433 million for the quarter, up from £381 million last year, even though the number of people falling into default remained low. This suggest the bank expects (unsurprisingly) that the worst for consumers is ahead and not behind us.
Second, on the corporate and investment banking front, Barclays saw income fall by a significant 6%. It’s worth noting that global markets are now seeing some decent growth — but this division generates the lion’s share of Barclays’ profits and investment banking income is like gym gains.
It takes years to build it up and weeks to lose it. And getting it back again is much harder than retaining it in the first place – because unlike gym gains, there’s always another bank waiting to take your business.
Third, there’s the controversy with former CEO Jes Staley to consider, and also the April 2022 structured notes blunder which was both costly and also deeply embarrassing for current CEO Venkat. For context, Venkat was a risk specialist at JP Morgan for more than 20 years, and formerly held the position of Chief Risk Officer at Barclays. Investors may be nervous that a similar problem is waiting under the waves, ready to be uncovered by rising rates.
On the other hand, the bank is severely undervalued on a price-to-equity basis — and the removal of the cap on banker bonuses could see some superstars move to London very soon.
easyJet shares were trading for 437p immediately before its recent trading update but have now fallen to 359p. This despite:
- record Q4 profit before tax, expected to be between £650-670 million
- passenger growth up 8% over the year
- the achievement of pre-set FY23 financial targets
easyJet is also very well hedged for jet fuel despite fears that a wider Middle East war could see Iranian oil exports collapse alongside a closure of the Strait of Hormuz.[6] It’s even got a medium-term target to deliver more than £1 billion of profit before tax — and longer term, is planning to nearly double the size of its fleet while also promising near-term dividends.
Of course, if oil remains elevated then presumably so will inflation. Usually the cure for higher oil prices is higher oil prices, but geopolitical stress remains at a high. easyJet could see a nightmare scenario where it’s got a huge fleet of planes it can’t fuel cheaply or sell tickets for at a reasonable margin.
Then there’s the plan to deliver dividends alongside a costly expansion — while the company has a solid cash position, this strategy is tough to market to investors used to enjoying one strategy or the other.
The bottom line
JP Morgan’s Jamie Dimon recently warned that ‘this may be the most dangerous time the world has seen in decades.’ Recently, he also slammed central banks for being ‘100% dead wrong’ with their economic forecasts and echoed a UN warning that ‘the risk of a nuclear weapon being used is currently higher than at any time since the depths of the Cold War.’
Risk abounds but risk appetite does not.
Alphabet, Barclays and easyJet should all be rising after delivering solid results. Instead, they’re falling. On a fundamental basis, all three are very undervalued, but short-term market directions are based on sentiment.
It doesn’t matter that Alphabet’s revenue rose by double-digits beating everyone’s expectations, because they missed Cloud estimates by a piffling $140 million. It doesn’t matter that Barclays also beat expectations — investors think high rates make banking too risky in the wake of the SVB and Credit Suisse crises. Even the major American banks are all falling this year.
And it doesn’t matter that easyJet posted RECORD profits — the airline is still in freefall because investors think there’s a chance oil will remain high even as the world enters a global recession.
That’s the market lesson of the week: fundamentals are for five years from now. Sentiment is for today’s buy-in price. Time in the market beats timing the market, but a little timing hurts nobody.
For context, oversold blue chips I called last year included Meta Platforms and Rolls-Royce.[8] Both have now recovered sharply — and at some point, Alphabet, Barclays and easyJet will also become excellent value. However, all three likely have room for more falls as the negative feedback loop of sentiment-induced selling continues.
And for those remaining solely in the small cap market — you’re in good company — poor sentiment is everywhere.
But it won’t last forever, and with rates near a peak, the time to buy is imminent.
This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.
Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.
