15 October 2019 – Earnings season reminds investors what really counts; Brexit has another crunch week; and Extinction rebellion reaches the City.
Another very busy week is underway for investors with crucial developments on a range of fronts. Top of the list, however, after a long period in which profits have not been the main focus will be the third quarter earnings season which kicks off, as usual, with the banks.
The key question for investors is when a weak outlook for company earnings might start to hit share prices. If analysts have got it right, the July to September quarter will be the third in a row to deliver lower earnings. That’s the worst run of poor profits for three years.
The consensus view at the moment is that earnings will fall by a little over 4% in the S&P 500. The falls in the first two quarters of 2019 were much more modest, under 1% both times.
What’s hitting profits is higher costs - both input and labour - which is cutting margins. Wage growth is not excessive but it has been rising for several years in the US. The strength of the dollar has not helped either. As in the UK, an export led market suffers if the currency is too strong.
Banks kick things off this week with results from JP Morgan, Chase, Goldman Sachs, Citigroup and Wells Fargo. Earnings are expected to be nearly 2% down for the sector. Falling interest rates are a key problem. Banks find it hard to make profits when rates are low and they can’t benefit from a wide gap between deposit rates and what they can charge for loans.
Elsewhere, energy is looking at a big decline in profits as the oil price falls. Technology has also been caught up in the US-China trade war and looks vulnerable.
In a consumption-driven economy like the US’s, however, it’s spending in the shops and other parts of the service sector that matters. With unemployment at a multi-decade low this has not been a problem but sentiment surveys are weakening ahead of the key Christmas period.
With investors worried about the likelihood of a recession in 2020, the market will be as focused on the outlook for next year as the reality of this year’s results.
Analysts are still optimistic about next year, with eps growth of 10% still forecast. That may start to look too positive as earnings season unfolds.
And if earnings forecasts do start to come back through the fourth quarter we may well start to question whether markets are right to be sitting close to their all-time high. The last three months of 2018 were testing for investors as the S&P 500 fell 14%. Everyone is hoping we don’t get a repeat of that slide this year.
Corporate news may be the main driver of long-term stock market returns but in the short term sentiment can matter more. And one of the key drivers of sentiment in the UK at the moment is clearly Brexit. This week is a big one for that tortuous process.
The key events this week are the EU summit on Thursday and Friday at which a decision will be made on whether the UK’s proposals to unlock the Irish border question can form the basis of a withdrawal agreement.
After an apparent thawing in discussions at the end of last week, the mood music soured a bit this week but this is par for the course when it comes to European negotiations. The bottom line is that both sides are keen for a deal and it wouldn’t be the first time that one was struck at the 59th minute of the 11th hour. A more likely outcome, however, remains a further extension until early next year to narrow the still wide gap between the two sides.
If an agreement can be forged this week then it’s back to parliament on Saturday to see if the deal can get the approval of MPs. Again, it’s far from a done deal but there are signs that the key refuseniks over the past three and half years may be veering towards getting Brexit over the line. Brexiteers know that this may be the last chance to achieve Brexit.
Given the complexity of the constitutional issues at stake, any solution to the border question was always likely to be anything but simple. Indeed, the answer seems to be a lawyer’s delight that can argue that Northern Ireland is both in and out of the Customs Union and Single Market at the same time.
Anyway, the odds of the UK leaving the EU on or soon after the 31st October are probably better today than they have been. Then the question would move onto what to do about a Government without a majority. And then in turn what to do about Britain’s ongoing relationship with Europe in a post-Brexit world.
Leaving the EU was only ever the start of a process. Saying Just get Brexit Done was always going to be like saying to a pregnant woman, just get the child done.
As ever, the pound has been the barometer of investor sentiment about the Brexit saga. At the end of last week, sterling enjoyed its best two days for years, almost reaching $1.27 before falling back on Monday as the mood darkened again.
The slightly surreal nature of UK politics was confirmed this week when parliament resumed after its short prorogation with a Queen’s Speech that set out a Government legislative agenda that almost certainly will never be enacted.
The reason for that is the absence of a Government majority in parliament and the very real possibility that the Queen’s Speech will be voted down by MPs for the first time since the 1920s. Even if it is not, the chance of any of the constituent bills being voted through is slim to non-existent. And anyway, an election or second referendum still looms in the wings.
It is best not to make any predictions about UK politics just now, just watch and wait and make sure that your portfolio is not too exposed to the UK until the dust settles.
The other big market driver recently has, of course, been the Trade War between the US and China. As with Brexit, the mood seemed to lighten over the weekend as a partial deal between the two seemed to become a real possibility.
On Friday, a truce appeared to have been reached after Washington agreed to hold off on tariff increases which had been due to kick in this week in exchange for some Chinese concessions, mainly on agricultural purchases.
The agreement, which Donald Trump described as a ‘substantial phase one deal’, will offer some respite to investors if it is followed up by a more substantive summit between the US President and China’s Xi Jinping.
Stock markets certainly responded positively to the news initially, although the S&P 500 gave back some of its gains later on Friday as sceptical voices started to emerge. One described the deal as more cosmetic than real despite a positive statement from Beijing that ‘a healthy and steady China-US relationship serves the interest of our two countries and the world at large.’
The fragility of the deal was confirmed this week when Steven Mnuchin, US Treasury Secretary, warned that a new round of tariffs, due to begin in December would indeed be triggered if China failed to seal the deal.
Finally, the week-long Extinction Rebellion protests moved a step closer to the investment world this week as climate protesters blocked streets in the City and protested outside the offices of BlackRock to demand the fund manager stop investing in fossil fuels. Further protests and road closures are expected in the City this week, confirming that ESG is a topic that the asset management business must embrace.