Mixed results, but market should know this; Riskreward is better for commodities and domestic plays
* Q3 results are upon us. Macro uncertainty is elevated, with a host of recent activity indicators showing weakness, such as EM PMIs, US ISM and corporate pricing datapoints. These suggest that earnings results are likely to be mixed, and corporates are not likely to be comfortable to issue
* We don’t think that the upcoming earnings results need to be taken negatively by the market, even if they are subdued:
1) Equities were weak into the current reporting season. P/Es have derated by 6% over the past three
months on average across US and Europe.
2) Hurdle rate has moved significantly lower. Consensus now expects US earnings to fall 3% yoy in Q3. Ex Energy, this moves up to +4%, but is still not demanding given the backdrop of 3% yoy nominal GDP growth. We note that
US corporates typically beat lowered expectations by 3-4%. This should be the case yet again.
* For Eurozone, the consensus projects 9% yoy growth rate, ex Energy. This is somewhat more demanding than the US, but Eurozone dataflow was more robust than the US one recently. This is seen in Eurozone CESI being consistently above zero during Q3, in contrast to the US CESI, which remained negative. In addition, Eurozone earnings base is lower than the US one. Japanese hurdle rate stands at 4% yoy, below recent delivered growth rates.
* Near-term earnings results are unlikely to add to the market concerns, in our view, but the bigger picture remains that US profit cycle is getting tired. US earnings are failing to grow for a few quarters now, NIPA margins appear to be rolling over. Yes, companies are likely to deliver their usual 3-4% beats vs the managed expectations, but the key point is that quarterly EPS beats are no longer driving upgrades in the US. The stalling in EPS momentum was one of the key reasons why we downgraded US to UW last November, within the context of a global portfolio. ’15 will be the first year since ’08 where Eurozone earnings growth is outstripping the US.
* Where could the results be taken positively?
1) Commodities. The earnings forecasts for both Mining and Energy might have undershot the moves in underlying commodity prices. IBES is projecting a 53% average fall in the US and European Energy EPS for '15. This
might end up being too bearish. We believe commodities should continue to squeeze higher, given still extreme shorts, clearly dovish Fed and potential turn in China dataflow. We reiterate our upgrade from 14th September.
* 2) Eurozone domestic recovery plays. The uptrend in earnings is clear for the space, in our view. Domestic indicators such as consumer confidence, M1 and credit conditions argue for this to continue.
* Which parts could disappoint? Capex/IP/PMI-related areas, such as Industrials, Chemicals and Tech. We think that these groups should continue to struggle to perform, given subpar global IP, weak capex orders, poor pricing and EM PMIs. Thematically, we have a preference for domestic plays over exporters, and for consumer vs corporates.