Market Update
This week investors continue to ponder softer inflation numbers, and what they may mean for the economy and markets. On Wednesday the UK also saw a surprise decline in its consumer inflation, leading the 2-year Gilt back below 5%. Sovereign yields across developed markets edged lower throughout the week. The 10-year U.S. Treasury yield is now back at around 3.75%, after an aggressive move higher over the last month. Equity markets continued to grind higher with the start of the earnings season, with the focus moving to regional banks and technology companies in the coming days. To many, the optimism looks premature, as arguably the end-cycle debate is far from settled. But the market has decided to keep its ‘soft-landing’ hopes – so this may well be the path of least resistance until the facts change.
Meanwhile in Greater China, the mood is decidedly more somber. China released a slew of activity data for June and Q2 GDP numbers, which overall paints a very mixed picture. The post-COVID recovery is ongoing, but in the absence of major policy stimulus it is advancing at a slow pace given that the economy is also dealing with a range of other issues – most notably the aftermath of a property slump. In response, analysts are lowering their GDP forecasts for China, again. Evergrande, the poster-child of the boom and bust property sector in China, released its much delayed 2022 financial results, revealing steep losses and elevated debt. The macro and sentiment downturn dragged the CSI300 Index lower over the week, while the Hang Seng Index treaded water. The RMB continued to hover around 7.2, torn between a weaker USD and a slow recovery in China.
In this week’s Asia Strategy Weekly, we turn our focus to the U.S. equity market. Amidst generally positive market sentiment, the Q2 earnings season has kicked off. With an unexpectedly strong market rally this year, the bar is clearly high for stocks that have performed well. As the reporting season ramps up in earnest, this week’s note examines what to expect and how to position for opportunities.
Strategy Question: Where are the opportunities amid the U.S. earnings season?
With 1Q23 U.S. earnings growth meaningfully better than expected at just -2% YoY, consensus is expecting a sequential deterioration with 2Q23 earnings to decline -7.5% YoY. However, this is largely due to two sectors: energy and materials – where weaker commodity prices are leading to deeply negative sector earnings growth of -48.9% and -31.7% YoY respectively. Excluding these two sectors, 2Q23 earnings in the U.S. are expected to be flat, which is a sequential improvement over 1Q23. In fact, seven out of eleven sectors are expected to see positive earnings growth this quarter. With recent company commentary at conferences, we believe these expectations are beatable. That being said, the S&P 500 is up ~17% year-to-date, and the bar is clearly higher for stocks that have had very strong performance this year. We will be paying attention to management commentary regarding margins – looking for signs of improvement or new pressures to help gauge potential further market upside. Our expectations are for other cyclical sectors that have lagged the rally to catch up throughout and after the earnings season. The equally-weighted S&P 500 is one way to implement this broadening of the rally in U.S. equities, in our view.
THE SEQUENTIAL DETERIORATION IN 2Q23 EARNINGS IS LARGELY DUE TO ENERGY AND MATERIALS
EPS growth estimates, %
THE AVERAGE EARNINGS SURPRISE WAS NEAR THE AVERAGE LAST QUARTER
S&P 500 earnings beat ratio
VARIOUS SECTORS ARE EXPERIENCING THEIR RESPECTIVE 'ROLLING EARNINGS RECESSION'
Quarterly sector earnings growth rates (4Q21 – 2Q24e), YoY %
EARNINGS SEASONS HAVE HISTORICALLY BEEN POSITIVE FOR EQUITIES
S&P 500 returns during earnings seasons, %
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Index Definitions
Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.
The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight - or 0.2% of the index total at each quarterly rebalance.
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The Hang Seng Index ("HSI"), the most widely quoted gauge of the Hong Kong stock market, includes the largest and most liquid stocks listed on the Main Board of the Stock Exchange of Hong Kong.
The CSI 300 Index is a free float adjusted, category-weighted index which measures the performance of A-Shares traded on the Shanghai Stock Exchange or the Shenzhen Stock Exchange. The Index consists of the 300 stocks with the largest market capitalisation and good liquidity from the entire universe of listed A-Shares companies in the PRC mainland.