A mixed earnings season & the US starts to slow

In a week where equity markets have been rather more volatile, two topics have particularly caught our attention – US corporate earnings and the US labour market. 

Most US companies are in the midst of reporting their quarterly earnings. These results give an important signal about how businesses are performing overall and allows management teams to comment on how they see the outlook developing over the coming months. 

The overall message so far has been mixed. The good news is that the majority of companies continue to deliver better earnings than analysts had expected and overall corporate profitability remains robust. On the less positive side, company revenues aren’t doing quite as well and that suggests that overall demand might be a bit weaker than analysts had hoped. Another factor to consider is the market reaction. We’ve seen that equity investors overall have punished stocks that disappoint more than in previous quarters, while good earnings results haven’t prompted stocks to move higher as they have in the recent past. This could suggest that expectations for these quarterly results were already quite high. We’ve seen that, particularly in some of the large tech companies that have driven the US equity market over the past few quarters. Results have been decent, even compared to expectations, but that hasn’t really been enough to push those stocks higher.

The second topic has been around the US economy and interest rates. This week the Federal Reserve left its policy rate unchanged, but did signal that labour markets were loosening a bit. We’ve seen various bits of macro data that suggest that the economy is slowing, most recently the Non-farm payrolls report that showed higher unemployment and lower job creation than expected. The ISM manufacturing survey from earlier this week also came in lower than expected. Analysts have been expecting the economy to slow, after a period of stronger-than-forecast growth, but now that the slowdown might actually be here, the worry is that it could be too much.

This combination of unspectacular earnings and concerns over an economic slowdown are weighing on equity markets. But we’re so far wary of making snap decisions about the outlook for risky assets. We aren’t currently expecting the US economy to tip into recession, although that’s something we monitor closely. We think softening the labour market will provide the Federal Reserve with a good reason to start lowering interest rates, most likely in September. It’s also reassuring to see the benefits of diversification coming through. As equity volatility has picked up, bonds have held up well, in some cases along with commodities. So we may be going through a period of equity market volatility, but at this point, we think this could provide an opportunity to increase equity exposure in some of our models.