Will Earnings Season Be Just What the Market Ordered?

2018/03/15
Will Earnings Season Be Just What the Market Ordered?

Summary

Hoping to regain some footing following a turbulent start to the year, markets could benefit from what appears will be a bright earnings season. We are looking to technology and financials, in particular, to set the tone for the broader markets.

After a turbulent March riddled with trade war rhetoric, a technology sell-off and escalated geopolitical tensions, markets may require a shift in headlines to steady and move higher. A solid earnings season may be just the catalyst to provide stability – and perhaps even some tailwind lift.

At first glance, first-quarter earnings are expected to be robust: up 17% year on year, the highest since 2011. Earnings expectations have also climbed for the quarter, from 11% in December, 2017, to 17% in April, 2018.

While it promises to be a favorable quarter for business, it’s important to remember a few key points.

Expectations are high for some sectors: look to technology and financials
Four sectors are expected to outperform overall S&P 500 earnings growth this quarter: energy, materials, technology and financials. Of these, we believe that technology and financials could receive substantial attention from the market and drive sentiment.

We have recently seen large-cap technology companies pull back, driven, in part, by data privacy issues, negative comments from the White House, accidents in the driverless car arena and the potential tariff escalation from China that may impact certain technology sub-sectors. Investors will be looking to earnings season for clarity and the impact of potential regulation, a weaker US dollar and tariff escalation.

For financials, many market participants hope to hear details of the new benefits gained from tax reform, rising rates and deregulation. However, given market volatility, many investors will also be keen to learn about the impact of volatility on bank trading volumes; while this could be a positive windfall, any advantage may be offset by a dramatically flattening yield curve. And as expectations remain high, we will also be watching if there is a sell-the-news reaction in the stocks, which may indicate a near-term peak in sentiment.

Technology and financials earnings could set the tone for the market entering the second quarter. While we expect both of these sectors to have solid earnings, management commentary may cast a greater shadow than it once did.

Chart 1: Great expectations for some more than others?
Energy, materials, tech and financials: four sectors are poised to be first-quarter earnings standouts.

chart

 

S&P 500 Earnings Growth: Q1 2018 (Source: FactSet)
Source: FactSet. As of 4/11/2018.

Upward revisions have stalled
Upward earnings revisions for the S&P 500 Index were strong in January and February but slowed in March. This is likely due, in part, to revisions moving upward substantially once tax reform was passed in late December, 2017, but slowing more recently because of market volatility and negative sentiment, specifically around trade and technology.

Within sectors, this slowdown in upward revisions occurred most substantially in telecommunications, health care, utilities and materials, although technology and financials followed closely behind.

Chart 2: Headlines and volatility dampen earnings revisions
Upward earnings revisions for the S&P 500 Index were lower in March than for the first two months of the year.

 

chart

 

Source: FactSet. As of 4/11/2018.

Data points to a peak year
More broadly, looking ahead 2018 still appears to be a peak year, both for earnings and economic growth. From an earnings perspective, estimates are for 18% S&P 500 earnings growth in 2018, followed by 10% in 2019.1 Similarly, consensus US real GDP growth in 2018 is 2.8%, followed by 2.5% and 2.0% in 2019 and 2020, respectively.2 This resonates with the view that we are likely late in the market cycle, which is often characterized by a peak in earnings and GDP growth. Furthermore, we see healthy equity market returns in a late-cycle environment, although with higher volatility.

3 trends support a shift in the narrative

Overall, we remain optimistic that earnings will be solid this quarter, and could shift the market to a more positive tone and outlook. What will be of utmost importance to the markets this quarter is management outlook and commentary, particularly for technology and financials companies.

While we are likely late cycle in the US market, we continue to believe that equity markets can perform well, albeit with higher volatility. We’ll especially be watching the following:

  1. Winners from disruption
    Our conviction continues to lie in the longer-term story of “winners from disruption,” and we will now monitor, in particular, if some of the larger technology disruptors will themselves be disrupted over time, perhaps through regulation.
  2. Financials may come out ahead
    In this environment, we also see a place for value sectors such as financials, which could benefit from market volatility (through trading) and a more domestic orientation. Financials may reclaim market leadership at some point in this cycle, given strong earnings, potential deregulation and rising rates, as well as uncertainty surrounding big-name technology.
  3. Staying active for alpha
    More generally, we continue to see a place for active investing in this environment, driven not only by elevated volatility, but also more rapidly shifting sector leadership, upon which active managers could capitalize as a source of alpha.

1 FactSet
2 Bloomberg


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Markets Wait to Learn Which Way the Fed Is Leaning

2018/03/15
Data-focused Fed still dovish, but Brexit looms

Summary

Having already factored in an anticipated 25-basis-point rate hike, the markets are now eagerly awaiting the Fed’s forward guidance from its March meeting. Continued strength in the US economy could prompt shifts in the FOMC’s tone and “dot plots” – and foreshadow more rate rises on the horizon.