Head of Equity Strategy
Summary: Earnings expectations are still rising but slowing down as the economy is slowing down due to supply constraints, China housing crisis, and the global energy crisis. The Q3 earnings season will be all about rising input costs and how it is driving margin pressures that could lead to many profit warnings. This is probably going to be one of the most exciting earnings season in many years.
Despite growth expectations are coming down due to supply chain issues in Asia due to Covid-19 outbreaks, China’s housing market crisis, and an unfolding global energy crisis, sell-side analysts have raised their 12-month forward EPS expectation for S&P 500 by 6.3% in Q3. This is the slowest pace in expected earnings since they bottomed out in May last year.
We are coming into the Q3 earnings season with elevated equity valuations and all-time high profit margins, and a growing list of pressure points for companies with wage pressures accelerating, supply constraints pushing up prices and now lately higher energy costs. Companies such as FedEx, Nike, and Bed Bath & Beyond have already fired warning shots of rising input costs and pressure on margins. We had expected this theme to dominate with Q4 earnings release in January, but we believe Q3 earnings will be all about input costs and warnings on margins which will surprise many investors.
The rising input costs for companies operating in the physical world will once again pressure companies in the industrial, consumer staples, and consumer discretionary sectors. We expect digital companies to do well as they generate higher amount of revenue and profits per energy input used and they often deliver their services over the Internet making them more immune to the global supply disruptions. Essentially another quarter that will show investors why betting on digital companies is good for returns, but it will only amplify the pressure on taxing digital companies and starve off physical companies of investments.
US financials will drive price action next week
The list below shows the most important earnings releases to watch next week with our focus on Delta Airlines, JPMorgan Chase, Bank of America and Citigroup.
Tuesday: Fastenal
Wednesday: Delta Air Lines, JPMorgan Chase, BlackRock, First Republic Bank
Thursday: Fast Retailing, Bank of America, Wells Fargo, Walgreens Boots Alliance, Morgan Stanley, Citigroup, UnitedHealth, US Bancorp, Progressive, Domino’s Pizza
Friday: Zijin Mining, BOC Hong Kong, PNC Financial Services, Goldman Sachs, Charles Schwab, Truist Financial
Delta Air Lines is expected to deliver Q3 revenue of $8.4bn up 175% y/y and its first profitable quarter since the pandemic started with EPS expected at $0.18, and EBITDA at $945mn translating into a healthy 11.2% operating margin. The key focus is naturally the rising fuel costs associated with the ongoing global energy crisis but also on how the uptake on air passengers look like in post pandemic world with vaccinations.
Among the banks and investment banks we focus on JPMorgan Chase for the full picture, and Bank of America for understanding the underlying credit dynamics and loan demand situation in the US, and Citigroup is interesting because of its emerging market tilt. Morgan Stanley and Goldman Sachs are often not interesting given JPMorgan Chase is most of the time a good indicator on investment banking for quarter. Analysts expect a tough quarter for US banks q/q as activity is normalizing across consumer and commercial banking while investment banking activity has not run abnormally high in Q3. Key focus for banks is their outlook for interest rates and any comments on inflation and how it is impacting their customers.
2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
