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US earnings season should kick the bears into touch

US earnings season over the next few weeks should help a more-positive market tone emerge

by
Garry White

in Features

16.04.2018

On Friday last week, Citibank, JP Morgan Chase and Wells Fargo kicked 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 negative returns, 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 18% year-on-year in the second quarter.

Friday’s results were reassuring. Citigroup beat expectations in its first-quarter earnings report, boosted by lower corporate taxes and strong revenue from equity trading. JP Morgan also comfortably beat Wall Street expectations, although trading revenue growth remained light. Wells Fargo also posted better-than-expected financial results for the first quarter, beating expectations on both the top and bottom line, but the stock fell 3% after reporting. The fall was a result of potential fines from regulators relating to the sales of certain auto insurance and mortgage products.

The most important thing for the US banking 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. This week, we have results from Bank of America on Monday, Goldman Sachs on Tuesday, Morgan Stanley on Wednesday and BNY Mellon on Thursday.

Investment banks should have benefitted 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 first-quarter deals hitting $1.2 trillion in value, as US tax reform and faster economic growth in Europe unleashed a wave of deal-doing. In the UK we have seen this unfold with firm bids or potential offers for a whole range of companies including GKN, Sky, Hammerson, UBM, Shire, FirstGroup 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 chair 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 Donald 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, although it eased towards the end of the month. 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. Military action in Syria has spooked some – sending oil prices to a three year high – but there are hopes the weekend airstrikes will not market the start of a long-term campaign. It is likely that the action won’t impact markets for long – and it is not in the interests of Vladimir Putin or Donald 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. Last week, Chinese Premier Xi Jinping said he will increase market access for foreign investors, something which has been a point of contention for the current administration. Indeed, plans for a link between stock exchanges in Beijing 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 mid-term 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.    

A version of this article appeared in Friday’s Daily Telegraph.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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