Head of Equity Strategy
Summary: We observe more signs of stabilisation in equities with volatility markets normalising and Italian government bonds coming back from the lows. But this week will be the ultimate test of sentiment with earnings from Apple, Amazon, Microsoft, Facebook and Alphabet (Google's parent) and these stocks have helped the equity market bouncing back faster than expected. Equity valuations remain extremely elevated and thus good earnings and a positive outlook from these major companies are important for sentiment.
Last week was the first real test in weeks of sentiment in equities with Friday showing buyers are still controlling the game. Earnings have had a similar pattern of generally disappointing and the majority of companies skipping their outlooks as the economic environment is too uncertain. Technology stocks continue to be bid higher and volatility futures are close to be in contango for the first time in almost two months. Italian government bonds (BTPs) are also bid this morning as Italy is preparing to open its economy again. Many small positive signs although the oil market is still sending distressing price signals due to massive demand and supply imbalance.
But more tests await investors this week with the most earnings week in many years. The five big companies Apple, Amazon, Microsoft, Facebook and Alphabet are all reporting earnings this week and with a combined index weight of 20.2% of these five names this will make or break equity sentiment. That five companies are now more than 20% of the S&P 500 is higher than what we observed during the dot-com highs and the energy dominance in the 1980s. A market cap concentration is always a sign of a structurally sick equity market and that a fundamental shift is coming. It’s also a sign of the narrowness of the equity market and the market is no longer reflecting the real economy – that’s being reflected by banks as the loans of Main Street sit on banks’ balance sheets.
Coming back to earnings we remain very sceptical of Facebook and Google’s earnings despite the positive surprise from Snap which we believe does not represent the overall picture of the online advertising market. Microsoft will most likely deliver to the joy of investors but could issue an outlook as Intel did with massive uncertainty related to the second half of the year. If many small companies go bankrupt globally it could impact the tail of Microsoft customers buying Windows, Office and Azure solutions. Apple could go both ways and is probably where there is the most uncertainty. On the negative side Apple could have been hit harder than expected due to stores closures, but then surprise on their Services segment as more customers have likely used the ecosystem buying apps, music etc. Amazon is really the dark horse this week. Revenue numbers will likely be up massively but margins could disappoint as the company has hired 100,000 extra workers, just increased pay for workers and the advertising segment could have taken a hit like Google and Facebook. With Amazon’s bigger and bigger market share and market capitalization the question of when the company will spin off its Amazon Web Services business (cloud) will arise and it could be a move from the founder and CEO Jeff Bezos to alleviate some of the anti-trust forces mobilizing against the company.
Besides the mega caps reporting this week we have oil majors, the big pharma companies, European banks and US credit card companies such as VISA and Mastercard reporting. Here the most important ones for sentiment are the European banks which are expected to post higher provisions for loan losses compared to the US banks as the economic downturn is expected to be more severe in Europe than in the US. The US credit card companies are also a must to watch as we expect severe deterioration in credit quality among US consumers and will be a good leading indicator on the health of the consumer.
Finally, while we observe increased stabilisation in equities we are also still observing equity markets being priced at elevated forward valuation multiples which are common with late cycle market behaviour than the early phase of a recession. Typically we observe compressed valuations, below the historical average, reflecting the uncertainty but also increasing the equity risk premium to entice investors to bid on assets. Low valuations are typically the main explanation for future returns which means that buying assets in a recession is a good thing for long-term returns. But this time equities have above average valuation on a forward basis and the economic shock has just started and not fully cascaded through all the layers of the economy. Enjoy the week.
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