BlackRock Commentary: Three takeaways from U.S. earnings

Jean Bovin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Alex Brazier – Deputy Head, and Carolina Martinez Arevalo – Portfolio Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points

Earnings outlook: U.S. corporate earnings have stagnated for a year, but Q2 beat a low bar. Expectations of improving margins look rosy. We stay selective in equities.

Market backdrop: U.S. stocks moved sideways and 10-year Treasury yields surged in volatile trading last week after CPI data. We see inflation on a rollercoaster ahead.

Week ahead: We’re watching inflation in Japan this week after the central bank loosened its yield cap last month. We see that pulling local and global bond yields higher.

U.S. corporate earnings have stagnated over the past year even as Q2 earnings improved a bit on better profit margins. We still see a margin squeeze ahead as worker shortages push wages back up, even if that takes longer to play out – our first takeaway. So the consensus for margins to expand into next year looks rosy, to us. Second, we see clear sector winners and stay selective with and within sectors that delivered earnings growth. Third, we see key regional divergences.

U.S. earnings have stagnated over the past year as pandemic-driven spending shifts normalized, squeezing profit margins. Margins ticked up in Q2, so earnings topped low expectations, partly from companies benefitting from lower input costs. We don’t think this will last. The consensus for profit margins looks too rosy – our first takeaway from Q2 earnings (green line in chart). Firms may struggle to pass on persistent labor costs to consumers: The share of businesses reporting higher prices for their products is the lowest since January 2021 (dark orange line), NFIB data show. We see companies facing higher labor costs from lifting wages to attract fewer available workers: The workforce is 4 million smaller than it would have been if it had kept growing at its pre-Covid pace, we find. The recovery of jobs lost in the pandemic has masked what has proved tepid job growth. Competition for workers should boost employee wages – at the expense of profit margins and shareholders.

We believe this structural labor shock is poised to take over as the driver of inflation as the pandemic-driven spending mismatch unwinds. That historic shift in consumer spending during the pandemic to goods from services created mismatches in production and consumption, and within the labor market as a result. It drove up prices and led to fatter profit margins, especially in the goods sector. Recent data showing a further sharp drop in goods prices in the July U.S. CPI and cooling Q2 wage data confirmed spending is normalizing. And that means profit margins are starting to normalize as well, even with the slight improvement in Q2.

Varied results

As worker shortages due to an aging population become more binding, we see firms needing to devote revenue to hiring or retaining workers – to the detriment of margins. We see inflation on a rollercoaster as the labor shock takes over from the spending mismatch. If companies try to protect margins from these wage pressures in a stagnant economy, that could add to inflation pressures and result in even higher central bank policy rates. We have evolved our macro framework to account for these forces.

Our second takeaway from Q2 earnings season: Tech met a high bar and selectivity is coming through in earnings. Other sectors that perform well as economic activity picks up fared better than expected, like industrials, communication services and consumer discretionary. As U.S. growth stagnates, it would be logical to question consumer sector resilience – especially as pandemic savings dwindle. But that’s the old playbook: The sector impact may be different. We think workers gaining income share from firms and unemployment staying low could reinforce consumer spending power for some time. We use our new playbook instead to get granular with and within equity sectors. Tech aligns with our preference for sectors delivering earnings growth. But we stay selective in tech with our overweight to the developed market (DM) artificial intelligence mega force theme, tapping into this structural shift within DM stocks, even when the macro is unfriendly to broad equity exposures.

Our last takeaway is regional differences. Q2 earnings of European firms contracted twice as much as U.S. peers, contributing to European stocks underperforming DM peers in recent months. Within DM, we prefer equities in Japan, where policy is still relatively easy, real rates are negative and shareholder-friendly reforms are taking root.

Bottom line

U.S. earnings are stagnating. Market expectations for a pickup in margins over the next year look rosy as worker shortages keep pressure on wages. We’re keeping a close eye on the labor market as a result and stay granular in DM stocks.

Market backdrop

U.S. stocks moved sideways below the 16-month high hit in July, with tech stocks underperforming after their sharp gains this year. Ten-year Treasury yields surged back near 15-year highs after volatile trading, partly due to a weak bond auction. The July CPI showed inflation cooling more. We see inflation on a rollercoaster ride ahead (see above). Market pricing of long-term inflation has diverged from shorter-term pricing, suggesting that markets see inflation pressures persisting longer term.

We’re watching GDP and inflation data across DMs this week. Inflation has returned in Japan but not as much as other major economies. The Bank of Japan (BOJ) is still unsure if higher wages are sustainable and can keep inflation around its target. Yet the BOJ loosened its yield cap again in July. We see that pulling local and global bond yields higher.

Week Ahead

Aug. 15: Japan GDP; China retail sales

Aug. 16: Euro area flash GDP; UK inflation

Aug. 18: Japan inflation


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 14th August, 2023 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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This information has been accurately reproduced, as received from  BlackRock Investment Management (UK) Limited. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The digest

Last week, global equities finished a rather lacklustre week lower, closing down slightly overall. Regionally, the S&P 500 Index closed the week down 0.3%, the STOXX Europe 600 Index was flat, whilst the MSCI Asia Pacific underperformed, down 1.7%. Rotation out of cyclicals and into defensives was noticeable globally, with continued poor Chinese macroeconomic data viewed as the key driver.

The US July Consumer Price Index (CPI) report was much anticipated but failed to provide much impetus either way, coming in in line with expectations. In Italy, a surprise banking tax brought volatility to the Italian banking space. Also, EU gas futures were up over 22% last week on news of a threat of strikes at Australian terminals.

The notable takeaway from the latest Bank of America “Flow Show” report was the further US$20.5 billion into money market funds. That makes US$145 billion of flows into cash so far in the third quarter, a faster rate of inflows than in in the second quarter, which indicates to us that long-only investors are still seeking safe spaces. There were also strong inflows into US Treasuries, with US$127 billion year-to-date. If we annualise that pace of inflows, it comes to US$206 billion, a record.

US equity funds saw their first inflow in three weeks, with US$1.6 billion. European-focused equity funds recorded their 22nd consecutive week of outflows, shedding US$3.5 billion. Meanwhile, emerging market equity funds received US$6.0 billion, marking five straight weeks of inflows.

Week in review

Europe

European equities finished last week roughly flat, despite a choppy week on low volumes.

Sector performance was mixed last week as defensives outperformed cyclicals. Health care was the leading sector last week, as Novo Nordisk’s SELECT trial data came in better than expected. Insurers were also higher on the back of positive earnings and following some recent underperformance. At the other end, basic resources were the notable underperformer following weak Chinese economic data. Autos were also weaker as cyclicals were sold last week.

Banks were also in focus last week on reports that the Italian government planned to propose a one-off 40% tax on excess net interest income in 2022 and 2023, payable in 2024. This led Italian bank stocks lower on Tuesday. More broadly, the FTSE MIB was down 2.1% on the day, whilst the overall European banking sector finished Tuesday down 2.7%.

After the market closed, there were reports the Italian government was backtracking on the initial announcement, applying a cap of 0.1% of total assets. This would lessen the impact quite markedly, offering the sector some relief. With that, the sector recovered some ground on Wednesday, although still closed lower on the week.

As noted, EU gas futures rallied last week on reports of potential strikes in Australia. However, stockpiles are rising in Europe and are currently above a 10-year high.

US equities were mixed last week, with markets lacking any clear direction. The Dow Jones Industrial Average closed the week up 0.6%, whilst the S&P 500 Index was down 0.3% and the tech-heavy Nasdaq was down 1.6%. US cyclicals underperformed defensives.

Federal Reserve (Fed) speak was mixed as Philadelphia Fed Bank President Patrick Harker noted the potential for rate cuts next year, whilst San Francisco Fed Bank President Mary Daly said the Federal Open Market Committee (FOMC) still had work to do to fight inflation.

On that note, the latest US CPI report came in largely in line with expectations at +0.2% on the month in July. The headline annualised CPI came in a little softer than forecast at 3.2%, but still higher than the 3.0% reading in June. The details showed more than 90% of the increase on the overall CPI was due to housing costs that have otherwise moderated since the start of the year. Used car prices fell for a second month, while airfares posted the biggest back-to-back declines since the start of the pandemic, down 8.1% on the month, and now down for a fourth straight month.

The rotation out of cyclicals was evident in overall sector moves last week, with health care and utilities amongst the outperformers and materials and technology stocks the key laggards. Energy stocks extended their recent rally last week, with help from a gain in oil prices. Banks were also in focus last week as ratings agency Moody’s downgraded 10 small/mid-sized US lenders on mounting funding costs and office exposure. Moody’s also put a host of other banks on watch, alerting investors.

Whilst there are still a few notable companies left to report, quarterly earnings season is starting to wind down, with nearly 90% of the S&P 500’s market capitalisation having reported. Overall, earnings have beaten expectations. More globally orientated S&P 500 companies are experiencing a greater decline in earnings-per-share growth than their more domestically focused peers.

Asia

Last week was down overall for equities in Asia. The MSCI Asia Pacific Index closed down 1.66% as the usual themes of a China economic slowdown, real estate weakness and Japan’s continued focus on yield curve control policy all weighed on sentiment.

Japan

On Friday, Japan’s market was closed Friday for Mountain Day, so there was a short trading week. There was a rotation out of cyclicals into defensives, with pharmaceuticals, food and utilities outperforming and precision instruments, banks and electric appliances underperforming.

Stocks tied to Japan’s reopening and inbound tourism jumped on Wednesday and Thursday after news that China would approve the resumption of Japan-bound group tours.

All eyes were on earnings last week as it was the peak of quarterly earnings announcement before the long weekend and Obon festival. However, volumes were surprisingly light, despite high volatility on the back of busy earnings.

The Japanese yen weakened against the US dollar, with the dollar trading up through 144 yen on Friday amidst the interest-rate differential between the two countries.

On the economic front, the consumer goods price index rose 3.6% year-over-year in July, marking the seventh straight month of slowing wholesale inflation. Also, wage growth unexpectedly slowed in June. These two indicators seem to support the Bank of Japan’s accommodative stance.

China

Last week was poor for Chinese markets, with Shanghai’s benchmark equity index closing the week down 3.01%. A few things continue to impact the market.

Inflation data showed that consumer and producer prices fell in tandem, highlighting the weak demand throughout the economy and raising concerns that China may be about to enter a deflationary period, despite recent statements from the Politburo on plans to boost the economy.

Authorities resumed travel groups to a range of countries including Japan, South Korea and the United States.

Regulatory crackdowns continue in China, with the pharmaceutical and health sectors the latest to face increased scrutiny from regulators. In addition to the focus on properties and financials, technology companies will catch some investor attention this week, as earnings from Tencent, Meituan, JD and Trip.com are expected.

The real estate space continues to be a major concern, as Country Garden missed interest payments on a couple US dollar bonds. The company announced on Friday that it’s facing record first-half losses, due mainly to rising costs and higher refinancing costs.

Softer trade and lending data was released last week, again highlighting the slowdown in the economy.

New bank loans rose less than expected in July, which could  prompt the government to increase stimulus measures in the near term.

This week, Chinese banks report earnings, with investors likely to be interested in the exposure to the property sector as well as any commitments that have been made to support the economy more broadly.

Hong Kong

Hong Kong’s equity market largely mirrored that of mainland China, closing lower last week on concerns that the downturn in China’s property market will persist and the slowdown in economic growth will deepen.

Chinese property developers weakened on the Country Garden concerns noted, whilst the auto sector sold off on softer China Passenger Car Association (CPCA) data and concerns of a price war in the electric vehicle space.

Health care firms plunged on the back of increasing government control and a continued anti-corruption campaign.

Week ahead

Macro week ahead highlights

This week, inflation is in focus with reports from the United Kingdom, Sweden, Japan, and a second reading of eurozone inflation in July. If core inflation remains elevated in the United Kingdom and Europe, the markets are likely to price in central bank rate hikes this fall. The latest UK unemployment release is also likely to attract attention—with an eye on wage inflation. Markets will also have an eye on a key sentiment survey in Germany.

Monday 14 August

  • Germany July Wholesale Prices

Tuesday 15 August                     

  • UK labour market statistics
  • Germany ZEW survey
  • US: Retail Sales Advance/Ex-Auto & Gas/Control Group (July), Export/Import Price Index/Ex- Petroleum (July), Empire Manufacturing (August), Business Inventories (June), NAHB Housing Market Index (August)

Wednesday 16 August

  • UK CPI Inflation
  • Euro-area Industrial Production (IP)
  • US Mortgage Applications, July Housing Starts, IP, August New York Fed Services Business Activity, FOMC Meeting Minutes

Thursday 17 August  

  • Spain June Trade Balance
  • Norges Bank policy meeting
  • US Initial Jobless Claims, August Philadelphia Fed Business Outlook, July Leading Index

Friday 18 August

  • Japan July CPI
  • UK Retail Sales
  • Euro-area final CPI inflation

 


Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.  Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 7th August 2023, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

Issued by Franklin Templeton Investment Management Limited (FTIML) Registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. FTIML is authorised and regulated by the Financial Conduct Authority.

 

MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Information Document (KID), which may be obtained from MeDirect Bank (Malta) plc.

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