Cautious Optimism On U.S. Earnings

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Key points

  • We're optimistic U.S. earnings will improve in the second half, but we believe the rebound may not be as big as many expect.
  • Global bond yields reached record lows last week amid a flight to safety and expectations for monetary easing post Brexit.
  • Central bank responses to the UK's vote to leave the European Union (EU) will take center stage this week and next.

The U.S. profits recession probably didn't end last quarter, with S&P 500 earnings likely to post a fourth consecutive quarterly decline. We see company earnings improving in the second half, but the rebound may be smaller than many expect.

A second-half U.S. earnings recovery will be underpinned by three key factors, we believe: a slowdown in the U.S. dollar's rise, stabilizing energy prices and solid consumption growth driven by rising wages. Yet a slowdown in capital expenditures (capex) may offset these positives. The amount companies plan to spend on capex in the coming 12 months has dropped to the lowest level since 2010, as the chart above shows.

What to watch for in 2Q results

The energy sector has driven much of the recent capex weakness, and capex is a less important barometer of sentiment in service sectors and asset-lite businesses. But we believe many companies may be reluctant to invest in an uncertain political climate marked by an impending Brexit and the upcoming U.S. presidential election. We will be paying close attention to any signs of reduced investment appetite in corporate guidance.

We will also be focused on earnings quality as second-quarter earnings season moves into full swing. The exclusion of asset write-downs in the energy and materials sectors and the use of aggressive accounting practices have inflated proforma earnings. We are watching for improvements in sales growth and cost controls - as well as the strength of demand that multinationals report seeing out of China and other emerging markets (EMs).

We see Brexit-related uncertainties weighing the most on already-depressed European earnings. Japanese and EM earnings estimates are also on a downswing. Bottom line: U.S. equities are the least dirty shirt of global equity markets, although high valuations keep our return expectations in check. We favor quality stocks and dividend growers.

  • Global bond yields reached record lows, amid an investor flight to safety and expectations for further monetary policy easing post-Brexit. Ten-year U.S. Treasury yields briefly touched 1.32%.
  • Financial sector stocks suffered as interest rates looked to be low for longer. Developed market financial stocks have lost nearly $1 trillion in market cap year-to-date, our calculations show.
  • U.S. payrolls data showed June hiring came in much stronger than expected, helping ease worries about the strength of the U.S. economy.

Global snapshot

Weekly and 12-month performance of selected assets

Equities Week YTD 12 Months Div. Yield
U.S. Large Caps 1.3% 4.2% 4.1% 2.2%
U.S. Small Caps 1.8% 4.5% -2.7% 1.5%
Non-U.S. World -1.5% -1.8% -7.6% 3.4%
Non-U.S. Developed -1.7% -5.4% -8.6% 3.6%
Japan -1.5% -6.4% -8.0% 2.6%
Emerging -1.2% 5.8% -6.1% 2.7%
Asia Ex Japan -1.1% 1.6% -5.6% 2.7%

Bonds Week YTD 12 Months Yield
U.S. Treasuries 0.6% 6.2% 6.3% 1.4%
U.S. TIPS 0.7% 7.6% 4.9% 1.4%
U.S. Investment Grade 1.1% 9.3% 8.6% 2.8%
U.S. High Yield 1.0% 10.6% 3.3% 6.9%
U.S. Municipals 0.2% 4.6% 7.6% 1.6%
Non-U.S. Developed 0.4% 12.7% 12.1% 0.4%
Emerging Market $ Bonds 1.0% 12.0% 11.3% 5.2%

Commodities Week YTD 12 Months Level
Brent Crude Oil -7.1% 25.4% -18.0% $46.76
Gold 1.9% 28.8% 18.0% $1,366
Copper -4.1% 0.1% -14.7% $4,711

Currencies Week YTD 12 Months Level
Euro/USD -0.8% 1.7% -0.2% 1.11
USD/Yen -1.9% -16.4% -16.7% 100.54
Pound/USD -2.4% -12.1% -15.7% 1.30

Source: Bloomberg. As of July 8, 2016. Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Barclays U.S. Corporate Index; U.S. high yield by the Barclays U.S. Corporate High Yield 2% Issuer Capped Index, U.S. municipals by the Barclays Municipal Bond Index; non-U.S. developed bonds by the Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

This post originally appeared on the BlackRock Blog.