Head of Equity Strategy
Summary: With negative momentum in equities as US bond yields have been rising rapidly the past couple of months this week's earnings from key US technology companies such as Microsoft, Alphabet, Meta, and Amazon are pivotal for equity sentiment. 12-month earnings expectations for US technology companies have been rising much faster than the S&P 500 Index underscoring that the stake are high this week. In today's equity update we also compare Q3 earnings results between the US and Europe.
US equities continue to be under pressure from higher US bond yields and uncertainty over the situation in the Middle East. S&P 500 futures are around 8% lower from their closing high back in late July. While higher bond yields suppress equity valuations holding everything constant, higher bond yields are often reflecting higher growth rates and as such there is a cancelling out effect between the two forces. In any case, with negative momentum in the equity market investors want to see a more positive outlook from companies. This earnings week is pivotal for equity sentiment and with earnings expectations rising much faster for the US technology sector the stakes are high.
Today the first two major mega cap US technology companies, Microsoft and Alphabet (parent of Google) report earnings after the US market close. These two companies are also the two first companies to report in our AI basket, which is seeing declining revenue growth if we exclude Nvidia suggesting the AI optimism is mostly felt in the VC-backed ecosystem and less in the established technology sector. Microsoft said in the previous earnings call that “AI sales” would be gradually rather than explosive suggestive of technology companies finding it difficult to quickly monetize on these new large language models.
Microsoft is expected to deliver revenue growth of 9%, which would mark the third consecutive quarter of rising revenue growth in a sign that the US software industry is holding up well. Microsoft’s EBITDA is expected to be $28.1bn vs $25bn a year ago. Key focus points for investors are the approved acquisition of Activision Blizzard catapulting Microsoft into a giant in gaming and uptake of its Copilot offering which is expected to be the first real test of a large-scale commercial generative AI application.
Alphabet is expected to report gross profit of $36.2bn down from $37.9bn a year ago as the online advertising is still experiencing a hangover from the boom period during the pandemic when large amount of advertising dollars were moved to online. Key focus points are any news on Google’s generative AI offering, cloud computing growth and lastly YouTube revenue and subscription growth compared to Netflix.
This week’s most important earnings are listed below. Besides Microsoft and Alphabet earnings tonight, we will also closely be watching earnings releases from Meta tomorrow and Amazon on Thursday as these two US technology companies will have a large impact on equity sentiment. Friday’s earnings releases from Exxon Mobil and Chevron are also going to be interesting given the mega acquisition both oil majors have recently done.
The US earnings season is in full swing with 18% of S&P 500 companies having already reported with 45% of those companies having positively surprised on revenue and 25% having disappointed against estimates on revenue. The revenue growth is currently 5.5% from the companies that have reported which is a significant increase from the 0.95% increase in Q2, but it is our expectation that the realized revenue growth in Q3 will come down closer to the Q2 level as more companies report earnings. The revenue growth rate is 4.7% if we exclude the financial sector which is right now experiencing higher revenue growth due to higher interest rates. The revenue growth surprise against estimates is currently 0.8%. The biggest revenue surprise has come from Freeport-McMoRan that reported last week revenue 6.4% above estimates. More interestingly the copper miner reiterated what everyone can see, that copper prices are still too low to justifying making new investments, which is a sign that copper prices will likely rise over time as electric vehicles adoption accelerates.
The highest revenue growth rates have come from sectors such as consumer discretionary, consumer staples, health care, and financials in line with the strong and robust figures we are getting on retail sales. On the negative side, sectors such as energy, materials, and information technology have so far reported overall negative revenue growth with materials being the worst driven by large declines from Nucor (-16%), Steel Dynamics (-19%), and Packaging Corp of America (-9%) as packaging prices are still declining as inflation is still suppressing volume growth in the economy. US steel prices are down 15% from a year ago.
One of the biggest disappointments in the US earnings season have so far been Tesla which missed on revenue and has seen its quarterly revenue stagnating for three consecutive quarters as the EV-maker has lowered its prices multiple times to offset the negative impact on demand from rising interest rates. Tesla’s CEO Elon Musk sounded the most downbeat in many years on the outlook for Tesla and EV-maker is facing increased competition, EU probe into its Chinese manufacturing (exported into the EU), and labour union pressures in Germany.
In Europe, 19% of the companies in the STOXX 600 Index that reports quarterly have already reported Q3 earnings results. Aggregate revenue growth is -2.4%, which in constant currency terms is likely much better as the EUR trade-weighted spot is up 5.6% from a year ago. The USD trade-weighted spot is -1.5% in Q3 compared to the same period last year. If we adjust for currency effects US and European companies are most likely growing at the same rate. Whereas more US companies have surprised on revenue against estimates, only 26% of reported revenue figures in Europe have positively surprised and 53% of reported revenue figures have negatively surprised. The health care and financial sectors have been the two best sectors on positive revenue surprise. One of the strongest revenue surprises actually came this morning with Logitech reporting revenue 8% above estimates as the business is improving faster than expected (FY revenue growth now expected at -9% to -12% from previously -12% to -16%). Logitech is also lifting its fiscal year guidance on operating income. Shares are up 9%.
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