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Trajectory shift

04 August 2016

While energy companies and banks have weighed on UK corporate earnings, corporate America’s second quarter looks somewhat brighter.

In recent years, it has become a truism that markets generally expect corporate earnings to beat expectations. Behind the celebratory news coverage, however, balance sheets and business outlooks may tell a different tale. For the three quarters up to March this year, US corporate earnings have been negative, despite continued headline GDP growth and the impressive performance of the US stock market. Nevertheless, profit expectations have largely been beaten.

The current results season appears to be offering more of the same: earnings both decreasing and beating expectations. Nevertheless, tracking a company’s recent direction of travel is at least as instructive as any assessment based on a single quarter’s worth of results. In the current environment, taking that longer-term view also leads to a more upbeat assessment of US companies. Thus, while second quarter earnings don’t look particularly good when taken in isolation, the longer-term trend (albeit with some companies yet to report) appears more positive.

According to FactSet, a financial research firm, some 63% of S&P 500 companies had reported quarterly earnings by 29 July. Of those companies, 71% had reported earnings above expectations, and 57% had reported sales above expectations. Moreover, while the first quarter had seen an earnings dip of 6.5%, the second quarter decline rate was just 3.8% - against the 5.5% rate forecast at the end of June.1

In the UK, where financial companies, oil majors and mining companies make up a significant portion of the FTSE 100, the index suffered slightly in the final week of July as earnings announcements gathered pace. Shell, BP and HSBC all declared hefty dips in profits.

The S&P 500 performed marginally better, reflecting in part the better results announced by its constituent companies. Among the better performers were Amgen, a biopharmaceutical company, and Baxter International, a healthcare company. Amgen revenues increased 6% and Baxter revenues increased 4.4%, compared to the second quarter of 2015.

“Amgen’s excellent results are driven by consistent, brilliant scientific and commercial execution,” said Jim Henderson of Aristotle Asset Management. “Baxter is benefiting from improvements brought by new CEO José Almeida, including a greater focus on operating margins and returns on invested capital.”

Tech boom

Differences between sectors were significant, and the earnings season found its redemption in the form of the US technology sector. All large US technology companies are listed on the NASDAQ, the world’s second-largest index. Indeed, the top six listings by market capitalisation are Apple, Alphabet (Google’s parent company’s two listings occupy second and third spot), Microsoft, Amazon and Facebook. In July, the month when most second-quarter earnings were announced, the NASDAQ grew by more than 6%, double the rate of the S&P 500.

Google and Facebook enjoyed particularly strong quarters. The former’s parent company Alphabet saw annualised profits rise 21%, while Facebook’s profits rocketed by 186%. Apple may have seen quarterly earnings fall 27% from a year before, but the company’s share price rose after the announcement since its performance had been far above expectations.2 Microsoft and Amazon both announced improved earnings.

The tech sector offers just one more reason why exposure to US stocks can be so valuable. Verizon, a leading US telecoms company, saw its own profits dip slightly against the second quarter of 2015, but expressed its commitment to expanding in the sector by recently agreeing the purchase of Yahoo, one of the pioneers of the internet. Google and Facebook remain far ahead of their peers for the moment, but technology is one of the fastest-moving sectors, and Verizon has new ambitions.

“Verizon has been strategically looking for new ways to generate revenue from its customer relationships and the enormous amount of data that flows over its network,” said Paul Boyne of Manulife Asset Management. “Yahoo brings scale which will allow Verizon to deliver not only advertising but also to collect and analyse online behaviour, which can create value. The Yahoo acquisition may allow Verizon to take the number three spot in the digital market, which we believe will add meaningfully to its revenue growth.”


Aristotle Asset Management and Manulife Asset Management are fund managers for St. James’s Place.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The opinions expressed are those of Jim Henderson of Aristotle and Paul Boyne of Manulife and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.

 

1https://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_7.29.16/view

2Source: Reuters

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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