Issue 94: Earnings Are Upon Us!

This Week’s Highlights

• Second-quarter earnings ramping up
  We’re a few weeks into Q2 reporting season, with high expectations for growth in corporate profits, especially among Mag 7 stocks, and investors looking to results not only for gauging individual companies’ performance, but also in search of clues as to the health of the American consumer.
• June retail sales surprise to upside
  Given how important households’ spending is to the fortunes of the US economy, markets have been increasingly disappointed with subpar retail sales over the course of 2024. As such, markets were quite happy with June’s report of a 0.8% month-over-month rise, excluding gas and autos.
• Roundup of developments in EM
  While most investors’ focus on the US economy is understandable, we thought it would be useful this week to survey some items from across emerging markets in recent days, including the monetary policy experiences of Turkey and Brazil, as well as India’s handling of a retail trading boom.

The CIO’s Take:

• As active equity investors, earnings season sees us glued to our Bloomberg terminals, taking in the results. Given lofty expectations in Q2, we’re especially attuned to the sentiment revealed in comments on a slowing economy and softer forward guidance. Given high valuations, we expect the penalty for falling short will also be severe.
• While it’s always interesting to hear what Fed officials have to say, we know they’re “data-dependent” and so the numbers on US economic strength get a heavy weight in our predictions of when the Fed will be ready to ease. Solid June retail sales suggest consumers aren’t tapped out just yet—though it’s probably only a matter of time.
• We’re always reminding readers that the emerging markets are a heterogeneous bunch, and it’s been interesting to watch extreme economic and financial conditions play out across different countries in different ways. One big takeaway? Regardless of what the US is doing, we always see opportunities to play shifts in international stocks.

Earnings Are Upon Us!

High bar for second-quarter earnings
In recent quarters, it’s almost seemed as though Nvidia’s reporting is an earnings season unto itself, though we’re reminded there are 499 other firms in the S&P 500 Index whose quarterly financial releases offer us an important window into the health of corporate America. Those reports have begun to kick off, as around 14% of S&P 500 firms released earnings through last Friday. At the end of June, FactSet data showed analysts expected YoY growth in Q2 earnings to reach 8.9%—pretty high expectations!

EPS growth biased toward Mag 7
Of course, such projections are skewed by the astonishing pace of growth among a small set of stocks. As of last Friday, four stocks in the Mag 7—Nvidia, Amazon, Meta, and Alphabet—were expected to report second-quarter earnings growth of over 56% YoY, versus 5.7% for the rest of the S&P 500. For its part, Netflix, the first Magnificent 7 stock to report this season, put up better-than-expected results last week, including topping analysts’ forecast of subscriber growth, though the firm issued softer guidance for Q3.

Expect caution on earnings calls
Netflix’s approach could be a trend to emerge from second-quarter reports, with managers seeking to temper Wall Street’s enthusiasm for growth—a tact that would be at odds with especially exuberant sentiment expressed on earnings calls in recent quarters (see below). If anyone is seeing strong signs of the US economy cooling, it would be the management at large firms experiencing those headwinds every day. Another trend that may not show up this quarter, but we do expect at some point, is convergence between growth amongst the Mag 7 and the rest of the market.

Corporate finance in good shape
Speaking of the rest of the market, the biggest group of firms to report so far has been the banking sector, often seen as a leading indicator of the health of corporate America. Those with major exposure to investment banking and trading have posted solid performance, benefiting from increasing visibility into monetary policy and inflation. The expectation of rate cuts, specifically, has been a boost to private equity and M&A deals. Meanwhile, a rising stock market has helped banks’ wealth business, with Goldman Sachs seeing a 27% search in wealth management revenues this year.

Signs of concern for consumers
It’s been a tougher go for consumer-focused banks, as higher-for-longer rates have not only raised deposit costs, but also squeezed lower-income Americans, whose budgets are pinched by inflation at the same time their own borrowing costs have skyrocketed. JPMorgan, Wells Fargo, Citi, and Bank of America all reported more consumers carrying credit card balances over in the second quarter, and large banks signaled they can see the economy cooling, boosting credit loss provisions. JPMorgan upped its allowance for bad loans from $1.9 billion last quarter to $3 billion in Q2.

June Spending Just Fine

Consumers facing major strain
On the question of how dire the situation really is for US consumers, we got retail sales data for June from the Commerce Department last Tuesday, shedding some light on the biggest contributor to economic growth. There have been concerns that with inflation biting into households’ budgets and rate cuts continually kicked down the road, a job market finally showing signs of loosening could spell trouble for consumers’ ability to spend. The San Francisco Fed’s calculation that pandemic-era excess savings ran out in March also hasn’t helped.

June retail sales surprise to upside
Despite all those gloomy factors, June retail sales data offered at least one more month’s reprieve, with the headline figure coming in flat month-over-month, and the year-over-year change tallying 2.3%. May retail sales were also revised upward. All of this was enough to soothe traders’ nerves, and markets reacted positively. Spending on gas was down 3% since May, and a cyberattack on CDK Global, software provider to car dealerships, resulted in a big chunk of June sales shifting to July. Excluding those two groups, retail sales actually jumped in June by 0.8% from May (see below).

Current trend probably unsustainable
We talked earnings before, and there are inklings among comments on earnings calls that the seemingly miraculous post-pandemic trend in the plot above might be running out of steam. Helen of Troy, for example, owner of consumer brands like OXO and Braun, reported Americans to be “even more financially stretched…further prioritizing essentials over discretionary items”; PepsiCo also saw its customers “more value-conscious”—even in the low-stakes domain of snack-buying decisions. The Fed is paying attention, of course, in assessing when it makes sense to start easing.

EM Odds and Ends

Turkey battles inflation from back foot
We highlighted above the US situation: Consumer resilience in the face of moderating economic activity and a central bank seemingly on track in its goals. But what about EM? As we’re always emphasizing, emerging markets are a remarkably varied group. Take Turkey, for example. Over a year into the country’s inflationary crisis, first met with a confusingly accommodative policy from the Turkish central bank, rate hikes have finally come (see below).

That combination—staggering levels of consumer price inflation, now paired with the bitter medicine of massive rate hikes, which have brought the Central Bank of Turkey’s one-week repo rate to an incredible 50%—has consumers reeling. Retirees, in particular, who saw monthly pension payments increase recently, from 12,000 to 14,000 liras, pales in the face of increasing prices. All that said, the currency has been remarkably stable, and the benchmark BIST 100 Index is up around 36% YTD as authorities finally align policy with the country’s macro reality.

Brazil pauses easing, growth target intact
There are also examples of countries with high inflation and currency risk that have done it better in terms of policy. Brazil is a case in point, recently leaving its growth forecast for 2024 unchanged at 2.5%—pretty good, considering many EM economies are increasingly concerned cooling US activity could see a global downturn. After being among the fastest to hike rates when inflation spiked, the country’s central bank had been easing, but recently held rates in place; June inflation was slower than expected, but still higher than the bank’s 3% target, at 3.9%.

India takes steps to protect retail investors
While Turkey and Brazil have plenty of doubters, there’s been much more consensus on India’s rosy prospects among countries in the EM basket. But it’s been a volatile market, and that’s something regulators tend to worry about. Along those lines, we see it as a positive sign for the market’s stability—and the sustainability of retail trading—that policymakers at the Securities and Exchange Board of India (SEBI) recently proposed creation of special higher-risk regulated funds for Indian retail traders, which will help to counter potentially dangerous, unregistered investment products.