U.S. equity markets declined over the third quarter of 2022 in U.S. dollar terms but rose in Canadian dollar terms on account of the declining Canadian dollar. The decline in U.S. dollar terms was a continuation of the selloff during the second quarter of 2022 and was driven by several concerns in the market, including the ongoing war in Ukraine, high inflation and whether rising interest rates will tip the economy into a recession.
For the quarter, Growth stocks outperformed Value stocks, mostly on account of the performance of two stocks: Tesla and Amazon. The outperformance of Growth over Value is a reversal from the previous quarters this year and has been driven mostly by the market’s short, but strong move higher in July. Consumer Discretionary, Energy and Financials were the strongest-performing sectors, while Communication Services, Real Estate and Materials were the worst performing.
Most of the market decline this year to date can be explained by price-to-earnings multiple compressions. Companies are now facing downward earnings risk due to weakening demand and higher input costs. MFS is concerned that while aggregate estimates have moved lower, they do not appear to fully reflect the deteriorating economic environment. The U.S. Federal Reserve has clearly communicated its intent to continue to combat inflation. U.S. dollar strength has also continued to be a headwind. While the stronger dollar helps to alleviate some of the inflation burden, about 40% of S&P 500 earnings originate outside of the U.S., putting significant pressure on profits at a time when demand is weakening and margins are in decline, suggesting an earnings-driven recession may be coming.
The Sun Life MFS U.S. Growth Fund underperformed its benchmark, the Russell 1000 Index (C$) over the quarter.
- A combination of both stock selection and overweight positions in Information Technology and Communication Services detracted from relative performance.
- An underweight in the outperforming Energy sector also detracted from relative performance.
- Stock selection in the Materials and Financials aided the Fund’s relative performance.
2022 has been a seesaw year for equities coming off three years of unusually strong equity returns. In 2020 and 2021, the unprecedented monetary and fiscal stimulus response to COVID helped lift equity valuations as much as three standard deviations above normal and allowed many low-quality companies to achieve record revenue growth, margin expansion and earnings. In MFS’ opinion, these trends were not sustainable, and the result has been an unwinding of these excesses with a selloff that has been indiscriminate of quality or earnings sustainability. While investor sentiment is very pessimistic and markets may appear oversold in the short term, MFS believes global earnings growth will decelerate and it will take time to work through some of the excesses and the impact of rising interest rates and inflation.