October is shaping up to be an important month for the stock market’s direction going into 2022. A lot is going on, including potential profit warnings due to supply chain difficulties and raw material price rises through the quarter. Meanwhile, miners have recently been sold off on the back of weaker commodity prices due to fears over China’s property market. It’s a confusing picture, so let’s try and simplify matters by looking at three things to expect this month.
Many industrial companies will give disappointing full-year guidance
I’m pretty confident on this one. It’s no secret that manufacturing companies faced a complex environment in the third quarter. If it wasn’t rising raw material prices, it was supply chain difficulties holding back production.
Indeed, FedEx (NYSE:FDX) recently reported its first-quarter 2022 earnings and warned of labor shortages leaving its hubs running at low capacity. Industrial giant 3M (NYSE:MMM) management warns of inflation outstripping its ability to raise its prices. Paint company Sherwin-Williams (NYSE:SHW) has already lowered its full-year guidance amid rising costs and raw material shortages.
These dynamics are illustrated in the following chart from the Institute of Supply Management (ISM). The good is that new orders remain high (a reading above 52.8 indicates an expansion in orders). However, prices paid are very high (a reading above 52.7 is seen as inflationary), and supplier deliveries are low (a reading above 50 indicates slower deliveries) as manufacturers continue to struggle to supply key products. Finally, very low customer inventories is an indication of how difficult manufacturers have found it to meet customer demand.
In this environment, don’t be surprised to hear management talk of soaring costs, difficulty obtaining products, and customers starting to defer production because they lack vital products. As such, the upcoming earnings season could see a lot of negative near-term outlooks and talk of issues extending into 2022.
Given the potential for some adverse shocks on earnings and guidance, it’s likely that some buying opportunities will arise, particularly if Wall Street focuses too much on short-term headwinds. There are a few reasons for this.
First, as you can see in the chart above, end demand (measured by new orders) remains strong. Companies are having difficulties delivering customer orders; it’s not that orders are falling off of a cliff. As such, there’s every possibility that revenue will be pushed into 2022.
Second, there’s already evidence that some raw material prices are moderating. For example, the crisis over China’s highly indebted property company China Evergrande Group (OTC:EGRN.Y) sent ripples through the commodity markets and sent iron ore (mainly used for steel production) tumbling. The reason is that China’s construction market is often the swing factor in determining steel demand and, ultimately, iron ore demand.
China’s property market will continue to be an issue
Unfortunately, the well-documented issues at Evergrande don’t appear to be isolated. Another significant property developer in China, Fantasia, recently missed a debt payment deadline. Rating agencies rushed to downgrade Fantasia’s debt rating.
The debt issues with China’s property companies are even more worrying, considering that the market is slowing in 2021. The chart below shows sequential month-over-month sales in residential property. June, July, and August numbers were notably weaker than in 2019.
Another point of concern is that September usually sees a return to sequential growth, but on a statement in mid-September, Evergrande’s management said, “The month of September is typically when real estate companies in China record higher contract sales” and then “The Company expects significant continuing decline in contract sales in September.” It’s not clear if this is an Evergrande issue or not, but it’s a worrying sign from one of the country’s largest developers.
It’s far from clear how a slowing property market in China will impact the global economy. Still, for now, it makes sense to be cautious on stocks with heavy exposure to the Chinese property market, such as Caterpillar or Otis.
Preparing for a difficult month
In a nutshell, I think October will be a volatile month, with profit warnings and weak-looking near-term guidance creating some shocks. However, it’s also likely that many investors will take a longer-term view and look to capitalize on short-term concerns. Meanwhile, China’s property market will remain a significant watch item.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.