Earnings season creates uncertainty around margins, inventories and guidance
Market Snapshot
Wall Street recorded a fifth consecutive month of gains in July, as we entered a critical earnings season with a lot of uncertainty around margins, inventories, and guidance.
While reporting season extends into August, most of the major sectors and industries have set their tone and we can start drawing conclusions. The easy bit is to look at some key metrics such as the fabled ‘beats to misses’ ratio (how many companies issued above consensus results and how many were below). This ran at an impressive sounding 80% rate, but this is a normal result.
Equally common is the 50% of companies who have theoretically surprised the market with the strength of their sales. Perhaps more importantly, eight out of the eleven sectors of the US market experienced outright sales growth, with seven of them converting those gains into higher profits. Overall earnings seem to be rising by 3 to 4% and analysts have been sufficiently pleased with the messages from companies to edge their 12-month earnings forecasts higher.
What did the earnings season in Europe tell us?
The picture has been less positive in Europe. The eurozone flirted with a recession and that is perhaps partially reflected in a weaker earnings season (although most European and US companies are global in their activities). Only c.50% of companies have issued positive earnings surprises, and sales and profits have, on average, declined. The composition of those beats and disappointments is similar in both the US and Europe, with commodity-based companies suffering the most severe declines in sales and profits due to lower commodity prices. Telecoms have been weak in both regions too.
Unlike the US, analysts have been paring back their forecasts for Europe, although that reflects the weakness of the dollar which will inflate the translated overseas profits of US companies (and vice versa for their European peers). So broadly, both earnings seasons seem to have been taken reasonably well by analysts so far.
The ECB said that while inflation continues to decline, it is still expected to remain too high for too long. However, its guidance appeared to switch from implying that further interest rates lie ahead to a stance of data dependency.
What is happening with the US stock market?
Investor sentiment was boosted by a flurry of better than expected US economic data. The core personal consumption expenditures price index – the Fed’s preferred inflation gauge – rose by 0.2% in June, down from 0.3% in May. This brought the year-on-year rate to 4.1%, the lowest since September 2021.
Meanwhile, US GDP grew by 2.4% year-on-year in the second quarter, well above expectations of around 1.8%, according to preliminary figures from the Commerce Department. This suggests the economy has been resilient despite the interest rate hikes.
A slowdown in consumer spending growth was more than offset by strong business investment in inventories and fixed assets. We saw the Federal Reserve and Central Bank vote to increase interest rates by 0.25%. The federal funds target range was increased, and this now stands at 5.25% to 5.5%, the highest in 20 years.
Inflation continues to slow and acknowledging that interest rates are probably at a restrictive level now, it gives the Fed licence to sit on its hands. Any wavering of that downward trend would complicate matters significantly with unemployment still low and the economy estimated to be operating around full capacity.
Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at RBC Brewin Dolphin)
