Half term report

As we reach the summer heights companies commenced releasing their latest set of financial accounts. Investors eagerly anticipate the quarterly results for insights into levels of corporate well-being.

Whilst earnings and sales will capture the headlines and analysts will scrutinise the accounts for signs of creative accounting. Investors will also look to verify valuations and seek out forward guidance. What we know at this point is that 172 out of the 500 US companies in the S&P 500 index have reported results so far. We also know that expectations for a good outcome have grown. This is clearly illustrated by the chart below. For this current quarter the estimate for earnings growth is a whopping 20%.

Profit levels this time follow on from impressive first quarter results, when earnings growth soared by 25%, surpassing the 17.1% expectation set by analysts.

Earnings growth this year is being supported by loose monetary conditions and new fiscal policies such as tax cuts which have energised the US economy. The relationship between growth in the economy and profits growth is a loose one because of many different factors at play. However, since Q3 2016 corporate profits and economic growth have tracked well together showing central bank policy and government policy are delivering positive effects.

S&P 500 Earnings Growth: Estimate vs Actual and US GDP (YoY)

Source: Factset, July 2018

Of the companies that have reported, 89% (153 out of the 172) have beaten earnings expectations; Technology, Financials, Health Care and Industrials are all doing particularly well.

If we go a little deeper there are some standout performers. As in the previous quarter, Goldman Sachs released impressive results. Profits surged 40% to $2.57bn in Q2, exceeding analysts’ estimates. Profits at Goldmans flowed from better-than-expected top line growth with revenues from their major businesses, with the exception of trading, all improving. Interestingly, the windfall from the tax reform enacted by Donald Trump, which reduced the bank’s effective tax rate for the first quarter to 17.2% from 22%, has now increased to 19.4%.This may be a first sign that the tax windfall may be starting to fade, but can still deliver good outcomes.

Other noticeable strong performers included Alphabet (commonly known as Google), which logged a 26% gain in second quarter revenues, something which may well have been missed amongst the headlines surrounding Facebook and Netflix. Harley Davidson, a firm caught up in the trade turmoil, topped Wall Street’s quarterly earnings estimates and their share’s rallied 9% after the company results. This has given hope that future profits will hold up better than expected despite the tariff obstacles.

Results so far have been encouraging but there is still a lot to be absorbed as more companies release results and issue forward-guidance. Once we have a complete picture of corporate earnings we will update you with more insight into profit margins across a broad swathe of corporate America with analysts looking for signs that they may be peaking.

China economic update: The slowboat to China gains more horsepower!

China is in the economic headlines again, this time as a result of positive intervention by from the Peoples Bank of China (PBoC).

Against a background of GDP growth, all western countries would very much like achieve a growth rate of 6.7%. Whilst above target, the Chinese government have felt the need to act by pulling various fiscal and monetary levers to support future economic growth.

Infrastructure spending is an integral part of economic growth for China. This has been on the agenda since 2013 with the planned $900bn ‘Belt and Road Initiative’ aimed at improving the country’s connectivity to Asia and the rest of the world. However, officials have seen a 36% year on year reduction in investment commitment from local government and have decided to act. This is because members of the PBoC State Council accused local government of acting inefficiently and sitting on fiscal revenue rather than using it to pursue infrastructure needs. By failing to spend as planned supply side improvements are being supressed and aggregate demand curtailed, two factors which if managed effectively can help fuel economic growth.

As well as requesting a change in the behaviour of local government to a pro-growth style, financial institutions are starting to be asked once again to make liquidity more accessible; including through shadow banking channels which hitherto have been clamped down on.

Debt driven growth has been in the veins of Chinese business and government since 2008 and it seems the pressures from the US may have the effect of putting President Xi Jinping’s deleveraging plans on ice. The second fiscal lever pulled is a $10bn tax cut for corporate investment in Research and Development in oil, gas, transport and telecommunications, all sectors which aim to enhance global connectivity and demand.

The announcements coincide with recent monetary stimulus measures including the PBoC’s purchase of Rmb502bn ($74bn) corporate bonds through the Medium-term Lending Facility (MLF). At the same time relaxed reserve requirements at the banks will free up $100bn for lending by making finance more accessible. This typically fuels business activity and investment.

In an economy with a GDP of $14trn the measures outlined may seem like a drop in the ocean, but this is one of largest monetary injections the economy has seen in a single day. It seems the government are navigating through a slowdown in growth and a debt laden economy and it is a difficult balancing act to pull off requiring skill and judgement. The policy has been well received by markets and on Tuesday, the CSI 300 Index experienced the best three-session run since March 2016 (up 5.5%) expressing confidence in China’s resilience against US protectionism.

The intervention by the PBoC proves again that Chinese Central Government is capable of making decisions, implementing quickly and demonstrating the economy’s ability to respond to stimulatory policy initiatives.

 

ECB July interest rate setting meeting – uneventful!

This week President of the European Central Bank (ECB) Mario Draghi reported on the ECB’s latest monetary policy committee meeting. Prior to the event the probability of an interest rate hike was at 3.4%. The low probability was anchored by strong forward guidance issued at the last ECB meeting in June. Back then, Mr Draghi confirmed interest rates would remain at historic lows “at least through the summer of 2019”. The ECB also announced an end to its bond purchasing programme, by December this year. However, the central bank said they would continue to reinvest the proceeds of assets which have matured “for an extended period of time”.

Economic data across the European economy has remained resilient since the announcement bringing bond buying to an end. European PMI figures remain well above 50, indicating that the Eurozone economy is still expanding. Furthermore, the Manufacturing PMI figures increased to 55.1, with manufactures shrugging off mounting threats of trade wars between the Eurozone and the US.

At the meeting Draghi gave a more upbeat assessment of the Eurozone recovery noting that the “euro area economy is proceeding along a solid and broad-based growth path” despite the uncertainties which surround “the global trade environment”.

An uneventful meeting, perhaps, but reassuring on growth. Markets where unmoved by the announcements as they matched the expectations of most market participants. The Euro was broadly static against the US dollar.

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