US earnings season should kick the bears into touch
Despite the geopolitical concerns, the bulls have many reasons to be cheerful over the next few months in the wake of Trump’s tax cuts
Later today, Citibank, JP Morgan Chase and Wells Fargo will kick off one of the most important US earnings seasons for quite some time. Following a period of market weakness, with negative geopolitical news driving markets, corporate reports over the next few weeks could keep investors optimistic. If current expectations are met, bulls are likely to breathe a sigh of relief.
Since the financial crisis, markets have largely been driven by unconventional polices implemented by central banks – but the stabilisers are now being removed. This means official-sector policies are becoming less helpful for equity markets.
After the first quarter saw what the City refers to as “negative returns” (that’s losses to you and I), bulls have been desperate for some positive news so they can get back in charge. Because there has been a dearth of earnings news over the last month, investors have been focusing on geopolitical “big-picture” issues, such as the Facebook data scandal, trade-war rhetoric and the worsening situation in Syria. However, good news may be ahead. Boosted by Donald Trump’s tax cuts, analysts are now expecting US earnings growth of more than 18pc year on year in the second quarter.
The banks reporting later today will help to set the earning-season tone. The most important thing for this sector is the level and direction of interest rates, as this directly impacts profitability through rates charged on loans. The recent increases in rates, coupled with a slight uptick in US commercial loans, should help on the earnings front. The banks also have a weak quarter of comparison figures from the start of last year, when there was relatively little market volatility and this was reflected in investment banking results. Investors will be hopeful this volatility has helped boost the bottom line, although it is likely to be lumpy.
Banks should also have benefited from the recent uptick in volatility and fee-generating merger, and acquisition (M&A) activity has been rising too. Global M&A had its strongest start to a year ever in 2018, with firstquarter deals hitting
$1.2 trillion in value, as US tax reform and faster economic growth in Europe unleashed a wave of deals. In the UK we have seen this unfold with firm bids or potential offers for a range of companies including GKN, Sky, Hammerson, UBM, Shire, First Group and electronic trading platform Nex. There is no reason that this market-supportive trend of companies pursuing transformative mergers cannot continue.
It’s hard to see equity markets continuing to underperform as earnings growth increases and global growth synchronises and accelerates. Two quarters of back-to-back negative returns when earnings are positive is usually an indicator that a recession is imminent, but this does not appear to be on the cards in the near term. Inflation in developed markets remains low and there are no signs of overheating in the real economy or in financial markets. New Federal Reserve chairman Jerome Powell appears unlikely to want to upset the applecart in his first year in the hot seat, so he is likely to err on the cautious side of tightening policy. This is especially the case as president Trump has a lot of his political capital invested in markets, as he has claimed responsibility for the recent bull run in equities on numerous occasions. We have also seen some better data, with global growth moving in synch and accelerating out of the range of the last few years. The US jobs market remains robust and consumer confidence across the Atlantic hit a 17-year high in March. House price growth is also strong.
Of course there are threats, with bears pointing to many of the issues that have been at the forefront of investors’ minds over the last few weeks in the absence of any earnings data. Potential military action in Syria has spooked some – sending oil prices to a three-year high. But any action is likely to be swift and targeted. It is likely that the action won’t impact markets for long – and it is not in the interests of Vladimir Putin or Trump to escalate significantly.
The potential trade war between the US and China is also a major threat – but these fears are potentially overcooked as well. Earlier this week, Chinese premier Xi Jinping said he will increase market access for foreign investors, something that has been a point of contention for the current administration. Indeed, plans for a link between stock exchanges in Shanghai and London were announced on Wednesday, which was a positive sign that Beijing is opening its doors to more foreign investment. It is likely that concessions will be made over the next few months so that both sides can claim a victory. Republicans are also likely to be wary of any market upsetting moves ahead of the midterm elections in November.
As the focus turns from geopolitical concerns to earnings, it’s now time for corporate America to start delivering. It is true that expectations remain quite high, and tax cuts are likely to be responsible for around a third of the earnings uplift – but this is likely to be the best US quarterly earnings season in seven years. This means there are definitely reasons to be optimistic ahead of the blizzard of numbers – and this will hopefully be reflected in equity markets.
‘Global M&A had its strongest start to a year ever, with $1.2 trillion deals’