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New lockdowns in parts of Europe don’t bode well for market sentiment
Thursday 25 Nov 2021 Author: Daniel Coatsworth

Austria imposing a full lockdown and Germany possibly following suit is not what the markets want to hear. Despite the ongoing rollout of Covid vaccinations, this pandemic is still raging on, and with it comes more disruption to consumers, businesses and the flow of goods.

We’ve just seen what happens when companies trading on high earnings multiples disappoint the market – their share prices take a big hit. What was already looking like a mixed year ahead for earnings growth is now looking even more fragile.

Steam engineer Spirax Sarco (SPX) has enjoyed very strong demand for its products and services in recent years, and had been seen as a resilient business during the crisis – up until now.

It makes pumps and tubes essential to Covid-19 vaccine production, among other items. Its share price retreated 5% on 17 November after saying it had been impacted by shipment delays.

Somewhat perplexing, Spirax didn’t downgrade earnings forecasts which leaves it vulnerable to further share price setbacks if it cannot hit those full year numbers.

In general, a company trading on more than 25 times forecast earnings doesn’t want to be letting investors down as the backlash can be brutal. The higher the rating, the greater the potential fall.

Fellow engineer Rotork (ROR) is in a similar situation to Spirax – demand is good but there are risks around fulfilling orders due to delays in getting components. It was trading on 30 times forward earnings when it issued a warning on 18 November, resulting in a 7% share price slump on the day.

It’s been quite a good year for a lot of companies, meaning investor expectations are high. Bank of America says the analyst consensus forecast for the MSCI US index’s earnings per share growth in 2021 is 48.8%. Although this only relates to the US market, the trend is relevant to investors worldwide.

That level of growth is significantly more than you might expect for a ‘normal’ year, but one must consider that the previous year saw so much disruption, causing a 20.1% drop in earnings for the MSCI US index, so 2021’s figure was a mixture of recovery and growth.

2022 is looking to be a tougher slog, with the consensus for US corporate profit growth dropping to 7.4%. If inflation continues to strengthen there is a real risk these profit expectations will have to be downgraded.

Don’t miss the 16 December 2021 issue of Shares which will feature our in-depth look at the key issues facing investors for the year ahead.

Until then, make sure you read beyond the highlights of any company announcement as the devil is in the detail. As we saw with Spirax and Rotork, both talk about strong demand but anyone who just flicked through the highlights would have missed the important bits further down in the announcements which triggered the share price declines.

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