The spotlight awaits the latest corporate earnings reporting season and for affirmation that the worst of the Covid-19 hit to profits has registered.
A couple of other factors will probably guide investor sentiment over the next few weeks into August. At the end of the week, the EU should advance plans for the bloc’s €750bn coronavirus recovery fund, while additional US fiscal stimulus appears a likely source of support for the economy.
These events loom beneath the surface of an impressive recovery in broad terms from the lows of March. Yet pricing across global equities is strikingly divergent. Morgan Stanley highlight:
“Cross-asset valuations suggest that the market is deeply suspicious of growth returning to normal.”
This is illustrated by the lagging recovery in smaller companies whose fortunes are tied to an improving economy. Indeed, Morgan Stanley write:
“Relative valuations for global small-caps versus large-caps are well below average, and low-quality stocks have almost never been cheaper to high-quality ones. The basis between BBB and A rated credit, and B and BB rated credit, remains elevated.”
Leading world 10-year bond yields remain contained, apart from the recent example of China’s benchmark jumping above 3 per cent. Oil prices are also fading a little, with chatter that this week’s Opec+ meeting does not extend production cuts.
All told, these nuggets hardly suggest a robust economic recovery beyond the horizon, and Chris Iggo at Axa Investment Managers cautions:
“There is a risk that the divergence between a gloomy economic outlook and unexpectedly strong returns from equity markets is reconciled by some pullback in asset prices rather than a surge in economic optimism.”
That accentuates the importance of what companies say when they outline their business activity expectations for rest of the year. Plenty rides on a recovery path that picks up the pace heading into 2021.
Here’s a snapshot of earnings estimates for the second quarter — versus the same quarter in 2019 — from FactSet. They note the expected year-over-year decline in S&P 500 earnings of minus 44.6 per cent would mark the largest drop since the final quarter of 2008 (minus 69.1 per cent).
As for the top line, revenues are seen declining 10.8 per cent y-o-y for the second quarter, the biggest drop since the third quarter of 2009 (minus 11.5 per cent) and FactSet note, healthcare stands out as the only big S&P 500 sector expected to report higher revenues. Utilities are seen having flat revenues y-o-y, while “the other nine sectors are predicted to report a year-over-year decline in revenues, led by the energy, industrials, and consumer discretionary sectors”.
What tells the story of the rebound in equity sentiment from March is shown via S&P 500 profit margins for the second quarter of 2019 and what is expected in 2020. As shown here via FactSet, there is a clear divide between sectors, with tech expected to show a drop of just 1.8 net margin points. Whereas the likes of financials and industrials face a drop of 9.5 and 7.6 net margin points respectively, or what DataTrek call the “have” and “have not” sectors.
DataTrek pose a question to the ranks of contrarians:
“You might nibble at those if you thought margins were going to come roaring back, but this seems unlikely just now.”
Others are more willing to back the likelihood of some narrowing between tech and cyclicals from here.
Julian Emanuel at BTIG thinks the dramatic divergence between the Nasdaq 100 — aka big tech — and financials this year to the tune of nearly 50 per cent, could well reverse during the latest earnings season.
Julian makes the point that the strong performance of Nasdaq 100 stocks require earnings that blow well past expectations, whereas the laggards such as financials are so beaten down, it may well be a case, “there is nowhere to go but up”.
Earnings season may well spur a rotation — although we really need to see a weaker US dollar and rising 10-year bond yields — and history shows that cyclicals usually perform very well once the trajectory of a recovery is clearer. But thanks to Covid-19 and the delicate process of managing the reopening of economic activity, relying on old playbooks may not prove so rewarding.
Quick Hits — What’s on the markets radar?
The China A shares trade is looking frothy argue JPMorgan’s Asia equity strategist team, and that was before this week began with China’s CSI 300 of Shanghai- and Shenzhen-listed stocks climbing 2.1 per cent. The benchmark has climbed 18.5 per cent this year, only trailing the Nasdaq juggernaut.
JPMorgan highlight via this chart: “Our China A-share sentiment index has hit ‘overheating’ levels,” and exceeds the prior high set during the first quarter of 2019.
Over at WisdomTree, Mobeen Tahir argues:
“There are good reasons for the strong ongoing rally in Chinese equities, and — although risks lurk on the horizon — we aren’t in bubble territory.”
“It also does not seem unreasonable to expect earnings for Chinese businesses to improve as the economy recovers in the second half of this year. This too, could help keep valuation multiples in check.”
Thematic investing dominates equity markets and analysts at Jefferies note the roll call of winners: these include, fintech, cloud solutions, artificial intelligence, education technology and online entertainment.
Hardly surprising that a select group of companies are exposed to a number of themes at the same time and have been rewarded by the share market.
“Seven stocks are leveraged to 3 or more themes at the same time. Alphabet (5), Microsoft (4), Tencent (4), Nvidia (4), Amazon (3), Intel (3), and Alibaba (3) are all exposed to multiple themes.”
Get alerts on Markets when a new story is published