Despite the recent spate of market volatility somewhat alleviating valuation pressures, the current earnings season remains an important indicator for the growth prospects of both corporate America and equity markets generally.
With the MSCI USA index trading at a forward PE of 16.7x, the US equity market is certainly not cheap and for equity markets to enter the next phase from here, we need to see evidence of earnings improving, or at the very least stabilising.
When reviewing 03 earnings, it is important to remain cognisant of the recent headwinds faced by US corporates (collapsing oil price, strong dollar, China slowdown) and to try to look beyond the headline numbers, which are being heavily influenced by the weakness of the Energy, Materials and Industrials sectors.
At present, the remaining seven sectors are all reporting or projected to report year-over-year growth in revenue and all sectors, excluding Financials, are positively surprising in aggregate on the earnings front (source: Factset/Bioomberg). On balance, we feel this, combined with the continued strength of a number of economic indicators (employment. housing, business confidence), is pointing to an economy in good health.
Although it is difficult to make any definitive high level judgements at this stage (so far 173 S&P 500 companies have reported), early releases have highlighted some interesting industry trends.
The big positive news story last week came out of the Technology sector, with Microsoft, Amazon and Alphabet (Google’s new parent company) all responding well to earnings announcements. Microsoft’s shares reached their highest point in 15 years in after hours trading on Thursday, as it reported a 2% increase in net income compared with the same quarter last year.
Alphabet, on the back of comfortably beating both analyst earnings and revenue estimates, announced a $5.1bn share repurchase, sending the shares up more than 10% in after-market trading. Meanwhile, Amazon reported another excellent set of results (revenues rose 23% in the quarter) and the share price has now doubled since the beginning of the year.
Elsewhere, the other sectors currently showing signs of positive top-line growth are healthcare, consumer services, telecommunications and utilities.
On the negative side, as expected we continue to see weakness out of Energy, Miners, and Industrials, while the main negative surprise has been the weakness of the banks and a few isolated stocks such as Walmart.
With regards to Walmart, it seems it is trying to adapt the business model to compete with Amazon, but the continued strength of Amazon is putting immense pressure on the company, and share price moves have been reflecting this all year.
The banks have suffered as a result of weak volumes within fixed income and commodities trading divisions, lower investment management revenues due to market volatility, and simply the fact that in the post-Lehman world, banks have been required to build up capital on their balance sheets, which has hit their income statements.
The weakness in Miners, Energy and Industrials has been well documented given the dramatic moves we have seen within the commodity complex, and it will likely be a number of quarters before we start to see positive figures out of these sectors.
In terms of portfolio implications, the US remains a large part of our overall equity exposure and within our higher risk strategies, we are explicitly playing US technology as a theme.
As we have articulated in the past, we are of the view that the underlying US economy remains on solid foundations and we expect this to start feeding through to corporate earnings.
Companies have faced significant headwinds with a strong dollar and uncertainty surrounding the global growth outlook, however we are starting to see some positive developments on the earnings front, which should be supportive for equity markets going forward.