Earnings Season Once More. Can the Bulls Survive?

Market sentiment towards the economic environment and outlook for the year ahead, the outlook for rate hikes, the longest government shutdown in history and, last but not least, progress on trade talks between the U.S and China, have been the market forces.

With the Dow in positive territory at the start of the year, supported by optimism over a trade and a shift in forward guidance by the FED, focus in the week ahead will be redirected towards corporate earnings, which could see some bloodshed in the equity markets in the weeks ahead.

Why the negative outlook?

Looking at the economic indicators through the final quarter of the year:

• The manufacturing sector has seen a marked slowdown in growth, with the U.S manufacturing PMI sliding to a 15-month low in December and on a downward trend throughout the 4th quarter.
• New order growth also fell to a 15–month low in December, with demand weighed by the stronger Dollar, weaker economic conditions overseas, rising interest rates and the ongoing trade war between the U.S and China.
• Input prices were on the rise due to rising oil prices that will have weighed on margins through the quarter.
• Business optimism also hit the lowest level since October 2016, which could be the killer blow for the sector, forward guidance on earnings as key as the actual results, which are certainly expected to be weaker than the preceding quarters of the year.
• Expect intermediate goods producers to be worst hit on the earnings front, with a downward trend on inventories across the broader sector pointing to lower stockpiling.
• Looking across at the service sector, which accounts for the lion’s share of the U.S economy, new business growth eased to its weakest since October 2017, with business activity growth slowing to a 3-month low.
• Business confidence also fell, hitting the lowest level of the year, which will likely lead to more conservative forecasts for the year ahead.
• A positive for service sector companies is that the average PMI for the 4th quarter matched a 3rd quarter 54.7, with strong labour market conditions and wage growth driving consumption.

Digging deeper, the FED’s rate hikes through 2018 will have impacted margins for a number of companies and industries. The effects of the U.S Tax Bill is also now in the past, with a less optimistic outlook towards the economy and demand also a negative. Forward guidance could ultimately see a material shift in earnings outlook, particularly for more leveraged sectors and companies.

Analysts may be forced to downwardly revise forecasts for the year ahead, in spite of some progress made on trade talks between the U.S and China. A continued rise in the number of downward revisions, which has led to the number of downward revisions now exceeding the number of upward revisions, will be the main area of focus as concerns over the economic outlook and earnings forecast deteriorate.

While the general consensus will be to avoid highly geared companies and industries most sensitive to economic conditions, bank stocks could be under pressure in the week ahead. Citigroup, Wells Fargo, JPMorgan Chase, Bank of America, Goldman Sachs and Morgan Stanley are reporting earnings through the week.

Bank stocks have taken a big hit since the U.S equity markets peak. The majority of the losses have come in the final quarter. Rising rate hikes have provided little support for net interest margins, with competition for depositors and falling mortgage rates through the 4th quarter pinning back net interest margins, with a negative outlook on loan growth also expected to also be a drag in the week ahead.

A silver lining is current values, with bank stocks having tumbled. Ultimately, with earnings forecasts for the last quarter having been cut by the most since the final quarter of 2016, the shift attributed to negative sentiment towards trading results, as well as a number of other factors outlined early, both actual and forecasts could see banks stocks pull back to levels not seen since 2016.

Expect the first set of numbers to set the tone, particularly if loan growth is a contributory factor to any weaker than expected results.