Markets Weekly podcast – 18 November 2024
18 Nov 2024
Corporate earnings and key central bank decisions
13 May 2024
In this week’s podcast, Dorothée Deck, our Cross Asset Strategist, takes us on a whistlestop tour of the latest releases from the first-quarter corporate reporting season. Topics include the market response to these announcements, the recent equities rally and a potential reacceleration in earnings growth.
As podcast host, Julien Lafargue also provides a round-up of key investor topics, including the US labour market, central bank policy options and UK inflation.
You can also stream this podcast on the following channels:
Julien Lafargue (JL): Welcome to a new edition of Barclays’ Market Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and I will be your host today.
As usual, we will first go through last week’s events before moving on to our guest segment. And, this week, I’m delighted to be joined by Dorothée Deck, a Senior Cross Asset Strategist here at Barclays Private Bank, to discuss the first-quarter earnings season as it comes to an end.
Dorothée is going to join us very soon but, first, let’s look at what happened in markets last week, and it was a pretty positive week for equity markets. In particular, the rally was boosted by weaker-than-expected macroeconomic data. In other words, bad news is good news once again. And the bad news last week, so to speak, came in the form of US jobless claims that were higher than expected, printing at 231,000, and really they equalled the nonfarm payroll that we got about 10 days ago.
And those two datapoints seemed to suggest some softening in the US job market which, as we know, the Fed has flagged as a condition for future monetary policy easing. So, the market really welcomed that softness in the US job market. The question really is how much softness do we need to see, and how much is too much? And we can discuss that in a second.
But the other key datapoint from last week came, once again, from a central bank, but this time closer to home, in the form of the Bank of England meeting. And the BoE’s forward guidance was somewhat dovish. In fact, according to Governor Bailey, the BoE would, and I quote, “need to cut bank rates in the coming quarters and”, and I quote again, “probably more than markets currently expect”. So, a pretty dovish statement, suggesting that cuts are coming and they’re probably coming quite fast.
In fact, we believe the central bank is likely to be cutting rates either at its June meeting or its August meeting. The June one will take place on the 20th and the August meeting will be on the 1st. So, definitely cuts are coming from the BoE.
Now, will the BoE cut before or after the ECB? Well, it looks like it could be right after, simply because we got the ECB minutes from the April meeting, and those further underscored that the central bank will cut rates at its meeting on 6th June. Now, there is always the chance that it doesn’t happen, but it almost looks like it’s guaranteed at this stage. In fact, the central bank noted the faster-than-anticipated disinflationary process and the minutes showed that some policymakers were ready to ease in April, but a consensus emerged to await further evidence as the next projection in June will allow a more comprehensive risk assessment.
So, clearly, both the ECB and the BoE are on track to cut in the summer. When it comes to the Fed, I think that the key developments, given a comment from the Fed itself and Jerome Powell, but also this softer-than-expected job market in the US, suggests that, well, hikes are seemingly out of the picture for now. And the market has, therefore, switched back to a more dovish stance, with any bad macroeconomic news being seen as good news for monetary policy.
Now, one word of caution is that this bad-news-is-good-news type of narrative can’t last forever, and bad news will become bad news eventually. So, it’s important not to get carried away. It’s nice to welcome some kind of softness in the US job market as it suggests that at least we’re not going to see a hike, and potentially a cut, but we don’t want to see too much of that softness, because then that will potentially put pressure on the economy and on companies’ earnings, which, as we know, are the main driver of upside for equity markets over the medium term.
And I think it’s a great segue into our guest segment with Dorothée to discuss exactly that, the key takeaway from the first-quarter earnings season. Dorothée, thanks a lot for joining us. Let me start by asking you a very broad question now that we’ve concluded the first-quarter earnings season. Can you just, maybe, give us some context and explain why this reporting season was particularly important and a real key test for markets?
Dorothée Deck (DD): Yeah, sure, absolutely. So, we need to take a step back and look at market performance ahead of the reporting season. So, as of the end of March, when companies started reporting their first-quarter results, global equities were up 25% from their October lows, and investor sentiment was quite extended, quite bullish. This was followed by a 5% pullback in markets in the first half of April, which has now been almost fully reversed, and we’re back close to the all-time highs.
Now, to put this in context, this is a remarkable performance, especially considering the sharp repricing in rate expectations that we’ve seen in the past few months. Remember, at the start of the year, the market was pricing in as many as six or seven cuts by the Fed this year. But, following higher-than-expected inflation prints in the US and more hawkish communication by the Fed, those expectations have been reduced drastically, and the market is now expecting only one or two rate cuts this year.
Over that period, US 10-year yields have jumped from 3.8% back in December to 4.5% today. So, the equity market has moved quite a long way, despite a number of headwinds, including higher yields and heightened geopolitical tensions. This rally has been driven primarily by a re-rating in anticipation of improved earnings momentum down the road. This means that a significant increase in corporate earnings is now required to justify the recent move in equity prices and for the rally to be sustained. This is why this earnings season was seen as a key test for markets.
JL: So, you said that solid earnings is required. Does that mean, in your mind, that we won’t see a lot of multiple expansion maybe, because, from a valuation standpoint, markets are fairly valued or even expensive?
DD: Yes. So when you look at valuations, global equities are currently trading on 17-times forward earnings, which is 17%, or one standard deviation, above their 20-year average. Of course, some regions and sectors are more expensive than others, but globally, at the index level, valuations look extended and they could come under pressure in the next few months if we see a deterioration in the growth and inflation mix.
We know that P/E multiples tend to come down in periods when growth expectations decline relative to inflation expectations, and this is precisely one of the key risks that the market is focusing on at present. And it is why it is so important that companies deliver on those earnings expectations in the coming quarters.
JL: Yeah, and it’s probably also why it’s important to be quite selective, I’d say. Now, in the last couple of years, and we’ve talked a lot about that, the fact that at some point the markets were thinking that a recession was coming, or a ‘hard landing’. Then the narrative evolved to more of a ‘soft landing’ and at some point, not too long ago, people were talking about a ‘no-landing’ scenario where the Fed would actually hike. That’s what people said. When you look at equity markets, what do you think they’re discounting at this moment based on valuation and maybe earnings growth?
DD: Yeah, and based on historical relationships with business surveys and corporate earnings, we actually think that the market is currently pricing in a no-landing scenario, with a significant pickup in economic activity and a strong reacceleration in earnings growth.
So, on our numbers, equity prices are currently discounting a 16% increase in global earnings this year, which is significant. And to put this into perspective, this is twice as high as the historical average over the past 50 years, and that’s also significantly ahead of analysts’ forecasts, which are currently predicting a 10% increase in global earnings this year.
JL: So, quite punchy expectations. And do you feel that in the earnings season that just concluded, those expectations were supported by the results? What’s your key takeaway from this quarter?
DD: So, in terms of where we are, we’re approaching the end of the reporting season, with roughly 80% to 90% of the companies having reported in Europe and the US. The results that have been reported so far have exceeded analysts’ expectations by 8% in the US and by 4% in Europe, primarily driven by margins. So, revenues have been broadly in line with expectations in both regions.
Now, it’s worth noting that analysts had reduced their earnings forecasts quite significantly ahead of the reporting season, which created a low bar for companies to beat expectations. Now, in terms of actual earnings growth, we’ve seen different trends in the US and Europe.
So, in the US, first-quarter earnings are up 5% year on year, primarily driven by three sectors, consumer discretionary, communication services and technology. If you exclude the ‘Magnificent Seven’, the earnings growth for the S&P 500 would be down 2% year on year. In Europe, first-quarter earnings are down 8%, hurt by the commodity sectors as well as industrials, consumer discretionary and technology. And, in contrast, the more defensive sectors, such as consumer staples, healthcare, communication services and utilities, have all managed to increase earnings year on year.
In terms of guidance, the majority of companies have maintained their full-year earnings guidance, which is good. And in Europe, companies noted that inflation pressures had moderated but not completely disappeared, and many companies noted that labour costs are a lingering issue for margins. But most companies were confident in their pricing power and ability to pass on higher costs to customers.
JL: So, it sounds like a relatively good earnings season, at least if you’re judging it compared to expectations, right? But the reality is most people will judge whether the earnings season was good or not depending on how their stocks have performed. So, how have those results been received by the market and by analysts?
DD: So, if I start with analysts’ earnings revisions. So, basically analysts’ earnings revisions have been positive, but the market reaction has been negative. So, going back to analysts’ earnings expectations, they have increased slightly in both regions for both 2024 and 2025, on the back of those positive earnings surprises. Nothing major, but a positive development.
Analysts now expect global earnings to grow by 10% this year and by 13% next year. We think it looks optimistic, given where we are in the cycle, and we think that corporate earnings are more likely to grow by below trend over the next couple of years, based on our economists’ GDP growth forecast.
Now, with regards to the market reaction, actually the share price reaction on the days around the earnings announcements has generally been more negative and more asymmetric than in the past. And what I mean by that is that the market has been rewarding positive earnings surprises less than in previous quarters, while punishing earnings disappointments more than average.
And this asymmetry is actually the widest it’s been on our records in both the US and Europe. Now, that’s not surprising given that investor sentiment and market positioning were both quite extended at the start of this season, quite bullish. That froth has not been cleared as sentiment and positioning have come down to more normal levels.
JL: Great. And I think it’s also important to realise that there are so many factors around how a stock will react to earnings, whether it’s the actual beat, whether it’s the guidance and the whether the guidance is good or bad. How the stocks had moved going into the earnings season always makes for quite a complicated read and that’s why, I guess, we tend to shy away from trading stocks around earnings.
Now, look, we’ve covered a lot of ground and just to conclude, with global equities back to all-time highs, at least definitely in Europe and in the UK, how do you think investors should be positioned right now?
DD: So, after such a strong rally in a short space of time, the upside potential looks limited at the index level, at least in the near term. Having said that, we have seen a significant increase in the dispersion of returns in the past few months and that has created attractive investment opportunities under the surface.
For example, we think that the recent procyclical sector rotation looks overdone. If the no-landing scenario doesn’t play out, and if the global economy doesn’t grow off trend in the next couple of years, that leaves upside potential for the more defensive parts of the market, such as consumer staples or utilities. And utilities have actually been the best performing sector globally in the past couple of months.
So, in conclusion, while the upside potential might be limited at the broad index level, attractive opportunities remain under the surface at the sector level and the stock level. So, in that context, investors need to be very selective, as you said earlier, very opportunistic, and they should favour active management as opposed to asset investing.
JL: Great. Yeah, clearly a lot to digest here, but I think that the key message is, you know, you have to be selective given where markets are and given what we’ve learned from the earnings season. Thank you so much, Dorothée, only a couple of months to go before the next earnings season but we’ll definitely get you back on the podcast even before that.
Now, moving on and to conclude, what to look for this week. Well, it’s all going to be about US inflation. We’re going to get the US PPI, the producer price index, on Tuesday. And on the same day we’re going to get an interesting datapoint, back to earnings, from Alibaba and Tencent, two Chinese companies. They will be interesting simply because Chinese stocks have been on a tear of late, being up some 25% from their January low. And, given the importance of those two companies, this is certainly going to be closely watched, as it could have an impact on sentiments towards the Chinese equity market.
But, in terms of this week, the main datapoint will be in the form of the US CPI data, that will come out on Wednesday. This is very important because, as we know, the Fed is paying close attention to inflation dynamics and so is the market. The year-over-year core number is expected to cool down by about 20 basis points sequentially, meaning we could see a core reading of 3.6% versus 3.8% in March, which would mark the largest deceleration we’ve seen since September 2023. And looking at this release, it looks like an in-line or even a downside surprise would help stocks much more than a hot figure would hurt, and that’s because of this softness in employment that we’ve discussed earlier.
Finally, we’re also going to get more Chinese data on Friday with industrial production and retail sales. Also, we do expect, as per media reports, to hear from President Biden on a new tariff on certain Chinese industries that could come as early as Tuesday.
So, a pretty packed week that we will, no doubt, debrief next week. In the meantime, as always, we wish you all the very best in the trading week ahead.
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