Markets Weekly podcast – 30 October 2023

Julien Lafargue (JL): Welcome back to a new edition of Barclays Private Bank  Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and I will be your host today.

We are back after a pause last week, and we have a lot to cover today. So, as usual, we’re going to go through the recent events in markets before moving on to our guest segment. And, this week, I’m very pleased to be joined by Dorothée Deck, Senior Cross Asset Strategist in our team at Barclays Private Bank, in order to discuss the ongoing earnings season.

But, first, let’s look at the recent events in markets and it’s fair to say the last couple of weeks have been quite challenging. Last week, the S&P pulled back again like most indices around the world. In fact, the S&P shed more than 2% for the week, and that was the case for a second straight week and has closed now at its lowest level since April.

Meanwhile, the Nasdaq is now around 12% below its recent peak in July. So, clearly, we’ve seen some consolidation in equity markets and the reason for that happening last week has been the same, actually, for the past few weeks is that bonds are in the driver’s seat. And last week we saw the US 10-year bond yield rising above 5% for the first time since 2007. Fortunately, it has retraced since then somewhat.

The Middle East is also becoming a bigger overhang amid fears that the Israel/Hamas war could turn into a wider Middle East conflict, something that keeps markets wondering what could happen, and we don’t expect this issue to be resolved any time soon, unfortunately.

Now, moving on to more macroeconomic considerations. Last week we got the October eurozone PMI came in at 46.5, and that was the fifth straight month of contraction, putting the composite PMI at its lowest level since November 2020. The manufacturing output was unchanged at 43.1 but with the headline index softening more than expected to 43.

Meanwhile, services softened by more than expected, falling by 0.9 points from September’s level. So, while this softening that we were expecting on the service side seems to be happening, we’re still waiting for a rebound in manufacturing.

As a result of that, and also taking into consideration recent developments on the inflation front, the ECB decided to pause as expected, but like other central banks like the Fed and like the BoE, the ECB left the door open to further hikes if necessary. We think they won’t be necessary.

Meanwhile in the US, Q3 real GDP growth came in at a stunning annualised rate of 4.9% and the strength was really broad based, but we do expect some payback in Q4 as a function of elevated inventory levels and a possible cooling of consumption, which is, by the way, something that many companies have signalled during the earnings season.

And talking about earnings, they’ve been mixed. And that’s me being generous. Among the US large cap companies, Microsoft and Amazon beat, Google disappointed somewhat however, and we’ll discuss that with Dorothée in a second. The issue is not so much with earnings per share but, rather … on the income statement as well as on the balance sheet side of it.

So, maybe that’s a good transition to bring you in, Dorothée. The quarterly reporting season is underway both in the US and Europe. I’ve mentioned some of my takeaways, so my impression, looking at the numbers. How do you see the earnings season developing so far? Are you seeing any sort of trend coming out of the numbers that are being reported?

Dorothée Deck (DD): Hi, Julien, thanks for having me. So, yes, the past couple of weeks have been very busy in terms of reporting activity. Close to 40% of the companies have now reported their third quarter results in the US and in Europe. That includes some of the largest companies by market cap, which tend to report early. So, in that sense, the results reported so far give us a pretty good indication of what to expect for the quarter.

I guess the key message is that the results have been mixed. While earnings have been stronger than expected in both regions, top-line growth has disappointed especially in Europe. And this is very much consistent with the divergence in economic activity seen in recent months where US data has been more resilient than expected, while European data has come in significantly below expectation.

So, in the US, third-quarter earnings reported so far are up 12% year on year, which is 8% ahead of analysts’ forecasts. All sectors are reporting healthy earnings growth with the exception of commodity sectors and real estate, which are flat or down year on year.

In Europe, earnings are down 8% year on year, but 3% above analysts’ expectations. European results are heavily distorted by two sectors, financials, which is contributing positively, and energy, which is contributing negatively.

If we exclude financials, third quarter earnings would be down 14% in Europe as opposed to 8%, and if we exclude energy, earnings would be flat year on year, so that’s actually a big change.

Now, if we look at topline growth, the proportion of companies beating analysts’ estimates is below historical average in both regions but it’s especially weak in Europe. Only a third of European companies have exceeded revenue forecasts, versus 58% historically, and this is a record low based on the sample of data going back to 2009.

In the US, around half of the companies have beaten sales estimates, versus 60% historically. It’s also worth flagging that the share price reaction in the US on the day of the earnings release has been more asymmetric than usual. 

So, the companies beating consensus estimates have seen a muted reaction broadly in line with historical patterns. However, the companies missing expectations have been more severely punished than usual. So, their share price has tended to underperform the market more significantly in the past.

JL: And I think that’s very interesting to know because, you know, numbers, and you mention numbers generally coming in better than expected, but we don’t see that transpire into the price action really, and I guess that’s because when a company publishes results markets tend, and investors, tend to be more focused on what the company is saying about the future. 

So, what do you think really the investors are being focused on at the moment, and have you heard something different or maybe something more cautious from management?

DD: Yeah, so if we take a step back, the macro environment is particularly uncertain at present. Growth expectations have come down. Inflation has remained elevated. Credit conditions have tightened aggressively. As you mentioned earlier, we’ve seen a surge in yields but also an increase in energy prices and geopolitical tension.

So, in that context, the reporting season is particularly helpful. Companies are telling us what’s going on in the real economy, what they’re seeing on the ground, and what’s their assessment of trading conditions in the coming months.

I think this quarter, investors are paying particular attention to a number of areas. Topline growth and any signs of weakening demand, pricing power as inflation remains elevated, the impact of higher rates on borrowing costs and delinquency rates, the availability of credit, as well as the impact of higher energy prices on earnings.

Now, if we look at company guidance for the coming quarters, the tone is notably more cautious. So, very few companies have raised their full-year guidance and we’ve seen a significant increase in profit warnings. Companies are generally more negative on the economy. They’re highlighting weaker demand, higher costs and a more difficult operating environment.

JL: And that’s an important point. I mean we’ve mentioned in the past that valuations on the equity market side appear rather full and, therefore, if you’re expecting any upside, it has to come from earnings. 

So, based on those rather cautious guidance from companies, what do you expect to happen to earnings expectations for the rest of this year and going into 2024?

DD: Yes, so analysts have taken note of the more cautious guidance and they’ve cut their estimates for 2024 in the past few weeks. Earnings revisions have come down in both regions, which means that we’ve seen more downgrades than upgrades. However, consensus expectations for 2024 remain too optimistic in our view and will probably have to be downgraded further.

Analysts currently expect earnings to grow by 11% globally in 2024, versus flat in 2023, and this looks rather ambitious given the weak macro backdrop and the high level of uncertainty. Our economists expect the global economy to grow by 2.4% next year in real terms, down from 2.8% this year, which is well below trend growth of 3.3%. And this type of environment is normally consistent with negative earnings growth globally.

Other indicators which tend to lead earnings growth also suggest that corporate profits are more likely to contract in the coming months. For example, US bank lending standards are consistent with a double-digit decline in global earnings over the next six months, while manufacturing new orders imply a mid-single-digit decline in the next nine months.

JL: Yes, I think it makes a strong argument for being rather selective when investing in equities because, as you were alluding to, if you look at the index level we could see some downward earnings revision and potentially some pressure on earnings expectations.

Well, look, since we have you here, thanks for covering the earnings season. Maybe we can take a step back and a broader view. You were mentioning the risk to earnings. So we’ve seen, as I mentioned in my introduction, equity markets pulling back quite meaningfully in the past couple of months or the past quarter so to speak. 

How much do you think is already priced in the market with all the uncertainty that there is out there? And can you maybe share some broad views on equity markets going forward?

DD: Yes. So, global equities have entered correction territory. They’re down more than 10% from their July high on the back of a substantial increase in yields driven by the long end of the curve. US Treasury yields have risen from 3.7% back in July to 4.9% today. So, that’s probably the main factor driving prices over this period, alongside the geopolitical events at the start of the month. But, despite the recent pullback, we think equity markets remain too complacent and disconnected from macroeconomic fundamentals.

So, at current level, and based on historical relationships, equity markets seem to be discounting a significant improvement in economic activity and double-digit growth in global earnings in the next six months, which is actually more in line with current analysts’ forecast. So, unless we see a reacceleration in economic activity and a rebound in profits, that implies downside risk to equity prices in the near term.

And, on that point, the more asymmetric share price reaction during the reporting season that I mentioned previously might be an early indication that the market is becoming more discriminating. And, in this environment, as you said earlier, it makes sense for investors to be more selective in their investment approach and favour active management as opposed to passive investing.

JL: I couldn’t agree more. It’s a challenging macroeconomic backdrop. It’s a challenging backdrop for companies, and we can see that even within the same sectors or same industry, you can see a very different reaction and very different performance, whether it’s from a business perspective or from a stock market perspective.

Thank you so much, Dorothée, that was extremely helpful. Some more companies are due to report, but I think we get a good picture already of what this Q3 earnings season is going to look like. So, thank you so much again.

Before we conclude, let me just wrap up by highlighting a few things that should be on your agenda for the week ahead.

Of course, as I mentioned, earnings are still an important focus for the market this week, but the number of releases from a macroeconomic standpoint is going to be quite important, in particular coming from different central banks around the world. 

So, we’re going to have the BoJ, Bank of Japan decision followed by the eurozone CPI inflation figure for October on Tuesday, the US JOLTS report will come on Wednesday, followed by the US manufacturing ISM for October. 

And on that same day, Wednesday is definitely going to be very busy, we also have, obviously, the FOMC decision, as well as right before that the quarterly refunding announcement by the US Treasury, and we know that last time this was published it created some volatility in the rates market.

Now, in the UK we will get the BoE decision on Thursday, followed back in the US by the US jobs report for October on Friday, alongside the US services ISM for October. 

So, a very, very busy week ahead from both a macro and a micro perspective and, of course, we will be back next week to debrief all that. But, in the meantime, as always, we wish you the very best in the trading week ahead.