Time to refocus attention on corporate earnings
For the past few weeks, investors have behaved like the tennis crowd on Wimbledon’s Centre Court, turning their heads back and forth, side to side. Should they pay attention to the antics in Athens, or was the sell-off in Shanghai more important?
Which was more dangerous: the potential collapse of the European Monetary Union or the bursting of one of the largest equity bubbles in recent years?
At the time of writing, both situations have been calmed down. Greece has the offer of a sizeable package of financial support, albeit many tortuous hours of political negotiations lie ahead. A U-turn by the Chinese authorities has stabilised the stock market, although their reform credentials have been damaged in the process.
As Wimbledon fades away, what new investment activity might take our attention for the rest of the summer? I would hope corporate earnings – the bedrock after all of why we invest in the stock market. July 9th was the starting gun for Alcoa to launch the US second quarter earnings season. What is priced into the market? Initially, the range of estimates was for small declines or small increases on a year-on-year basis. A variety of pressures are building: an expanding wages bill as firms take on more staff, the appreciation of the US dollar, lower commodity prices, changes in health care costs, to name just a few factors.
The summer saw profits downgrades as firms guided analyst forecasts lower – the key question now is whether they can beat them with positive surprises. The early start to the season has been quite interesting , for example surprises by US banks as loan growth picks up. It is noteworthy that the buy/sell ratio of recommendations from analysts is broadly tied in with the return-on-equity of stocks. As we expect the economic cycle to become more supportive for top line sales going forwards, so analyst recommendations and earnings forecasts should start to respond.
To sum up, as we navigate the Greek crisis and the volatile Chinese stock market, we can re-focus on the fundamentals – especially corporate earnings. We suggest that this will be a reasonably strong set of results globally, given the improving macro backdrop, more stable currencies and in particular higher operational leverage. Such news flow would support equities into the autumn as attention turns to the next game in town – the Federal Reserve’s interest rate decision.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Citywire Wealth Manager - 6th August 2015