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Portfolio > Economy & Markets

Earnings Season: The End of the Cycle Is Not Here … Yet

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They say that when America sneezes, the world catches a cold. Reality is never that simple, but the signals from U.S. earnings season are mixed and the sheer scale and diversity of companies listed in the U.S. means that the fate of the country’s companies is important for the world economy.

Earnings have been better than most analysts predicted. At the time of writing, around 75% of companies have announced profits that have beaten analysts’ expectations, according to  Institutional Brokers’ Estimate System data from Refinitiv. The same report shows that, on average, they did so by 6%. While this is an impressive figure relative to long-term trends, it demonstrates how low expectations were to start with.

Those low expectations were driven partly by companies themselves. In the immediate run-up to this earnings season, the number of profit warnings was more than twice as high as the number of positive or “in-line” pre-announcements. What we have seen so far on Wall Street is simply another round of “beat the lowered estimate.”

The Devil Is in the Details

Nonetheless, scrutinizing the company results themselves does reveal some interesting themes about the state of the U.S. and world economy. The results of Coca-Cola, Starbucks and McDonald’s show that the U.S. consumer is still bearing up in spite of worries about the state of the world’s largest economy.

In spite of global trade tensions and the yellow-vest demonstrations in France, Hermes reported strong figures, with sales growing at their fastest rate for five years. U.K. luxury fashion brand Burberry reported solid numbers boosted by the weakness of the pound. Both sets of results suggest that consumers of luxury goods in China have not been put off by their country’s trade spat with the U.S.

There was also good news from the semiconductor sector. Chipmaking is a cyclical business and there has been some cyclical weakness, not least involving Huawei getting sucked into the trade war. But the sector has surged back. The SOX Index, of semiconductor companies, briefly touched new highs and the share prices of a number of chipmakers increased sharply on the days of their earnings announcements. Texas Instruments, Terradyne, Intel and ASML all delivered positive surprises, reaping share-price gains in reward.

The industrial sector is proving much less resilient, though. Heavy machinery manufacturer Caterpillar is a bellwether for its entire sector, and the breakdown in U.S.-China relations was clear in their results. Cat’s Chinese machinery sales were weak, and the company pointed to the lower end of its earnings-per-share guidance for the whole of 2019. Honeywell, another heavy equipment specialist, also reported weaker sales in its industrial divisions, relying instead on its aerospace division to save the day.

Transportation was no less immune to the slowdown in global trade. North American railroad company CSX failed to meet projections for either earnings or revenue, as the volume of its domestic traffic fell. Another railroad, Norfolk Southern, saw volumes decline 4%, and also missed earnings expectations. More weak releases from the sector followed.

For now, investors have met the results in fairly black and white terms. Uncertainty about the state of the economy means investors do not have much faith in projections, so they seem to be taking earnings releases at face value. Good numbers have largely been rewarded and bad releases penalized. The slightly better than expected nature of this earnings season is likely to give the S&P 500 a leg up. The Federal Reserve cutting interest rates and companies continuing to buy their own stock will help, too.

But long-term investors are going to need more than liquidity from the Fed and technical encouragement like share buybacks. They will want to see evidence of real profit growth, generated at the company level, before share price gains can be sustained. And at this stage in the cycle there is no hiding from the fact that such evidence is hard to come by. America has not sneezed — yet.

Karolina Noculak, Aberdeen Asset ManagementKarolina Noculak is a multi-asset strategist responsible for tactical asset allocation at Aberdeen Standard Investments. She has been with the company for over a decade. Karolina holds an M.A. in finance and is a CFA charterholder and a member of the CFA UK Society. She is also the Chair of CFA UK Diversity Network in Scotland.


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