Risks in equity markets are piling up after record earnings season

(Bloomberg) — Delta cases. Inflation. Fed tapering. China’s crackdown. These are some of the reasons why investors may soon become more nervous about this stock market.

The S&P 500 hit another all-time high on Friday after Jerome Powell’s dovish taper speech reassured investors. However, the mood seems more cautious compared to a few weeks ago, when companies were in the midst of a record season.

All the concerns boil down to one big debate: Has the recovery from the pandemic already peaked? That is a question that will only be answered in the coming months. For now, investors say they are scouring management commentary and economic data for a hint of what’s to come.

“I’m not completely bearish, but I do see risks on the horizon that need to be watched,” said Marcus Morris-Eyton, portfolio manager at Allianz Global Investors.

Here’s an overview of the main risks ahead:

Virus variant

Even as the delta variant rages in many countries, the conventional wisdom among investors about the pandemic at this point is that vaccination will keep the coronavirus in check. The risk is that hospitals will once again become overwhelmed, forcing another round of lockdowns worldwide, knocking down the economy and key sectors such as travel, which has already been one of the worst performing groups in Europe and the US in the second half.

Fed Tapering

Of course, if the economy continues to ripple, it raises the prospect that the Fed will accelerate its plans to withdraw economic stimulus to keep inflation in check. Share prices have benefited from more than a decade of ultra-low borrowing costs that have prompted investors to invest in stocks. Higher interest rates would mainly hit the highest-valued stocks. “Any corresponding increase in bond yields due to a potential tapering decision could lead to stock derating,” Tommy Faber, fund manager at Waverton Investment Management.

Fed Chair Jerome Powell said on Friday that the central bank could begin reducing its monthly bond purchases this year, although it will be in no rush to raise interest rates after that.

For Fed Taper, forget when it starts. The end is more important

high bar

The second-quarter earnings season was one for the record books — 87% of companies in the S&P 500 reported better-than-expected results, a record number unmatched in nearly 30 years of historical data, according to Karolina Noculak, investment director at Aberdeen Standard Investments . Because beats are so widespread, there is a risk that expectations for the coming quarters are too high. “Investors have become quite accustomed to companies beating analysts’ forecasts,” she said.

Chips needed

A shortage of semiconductors affects everyone from tech giants to automakers. The boss of Germany’s largest chip company, Infineon Technologies AG, expects the episode to last until 2023. That means earnings growth for several industries is at risk for many more quarters to come.

Cost peak

The input shortage is not limited to chips. An undersupply of raw materials, shipping containers and labor affects many industries, driving prices up. Lysol maker Reckitt Benckiser Group Plc, Toshiba Corp., Tyson Foods Inc. and Henkel AG are among the big names affected by concerns that an increase in costs could hurt margins.

Chinese worries

China’s economic recovery falters as virus variants linger, and that is already seeping through to management commentary. Strategists at Jefferies warn that slowing Chinese growth will weigh on global profits and that there could be potential negative surprises as early as the fourth quarter.

That comes on top of Beijing’s recent crackdown on sectors such as technology, education and real estate. Louise Dudley, global equities portfolio manager at international firm Federated Hermes, said she is pleased with her underweight position in China. “The regulation we’ve seen so far has been pretty focused on technology,” she said on the phone. “Our expectation is that that will broaden.”

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