Political theatre versus earnings pantomime
Earnings trends may be broadly neutral, but we have become more cautious on equities.
Watching the autumn earnings season play out feels a bit like watching a pre-Christmas pantomime performance: the surprises are not so surprising, and you pretty much know how it’s going to end.
After a month of analysts cutting their estimates for third-quarter earnings, companies have now started to report results. Lo and behold, most of them are managing to beat those freshly lowered expectations. So far the earnings season has confirmed Lars’s view that it will not move the needle in the macro debate. US stocks are on track for another quarter of slightly positive earnings growth numbers.
Investors also tend to look particularly closely at company guidance statements, but unfortunately the records show fewer and fewer companies are issuing guidance. Given the binary nature of the macro outlook, who can blame them?
Perhaps the best thing one can say about this earnings season is that the headline numbers obscure a slightly stronger picture of underlying earnings. The median company should end up reporting a somewhat more impressive 5-6% year-over-year growth rate.
Overall, though, it seems likely that while this quarter’s reporting season won’t be bad enough to worry the bears, it won’t be good enough to get the bulls excited either.
So has the earnings story left us more bullish or bearish in our portfolios? After having been chickens for a few weeks, with a neutral equity position, we went short equities last week on a tactical and medium-term basis with a half-size conviction. Equities are close to their all-time peak, but uncertainty has significantly increased.
Our economists see a 30% chance of a global recession in the next 12 months and we are increasingly convinced we are late in the cycle. Yet while we have a cautious global economic outlook with risks tilted to the downside, Tim explained in his latest blog that if a US recession occurs soon it’s likely to be mild. We are not wholly bearish, therefore.
The buy-the-dip mentality that we’ve had for the past few years may nevertheless not be the right approach going forward. Manufacturing is already in a mild recession and this could disproportionally impact corporate earnings in future quarters. Our base case is for modestly negative earnings growth next year. That won’t be a tragedy in itself, but it does increase the market’s vulnerability.
On top of that, next year’s US presidential election looks set to be a spectacle of political theatre in its own right, with the possibility of more negative rhetoric on China from both Donald Trump and Democrats in the campaign, given that the party’s present front runner Elizabeth Warren is also a China hawk. The market could at some point contemplate the risk of a sharp move to the political left in the US, dependent on how Warren fares in the polls.
So, in the panto spirit, does a steady quarterly earnings season mean that risk is behind us? Oh no, it’s not.