3 themes emerging from second-quarter earnings season
On the latest edition of Market Week in Review, Senior Portfolio Manager Megan Roach and Research Analyst Laura Bardewyck discussed recently released economic data and results from second-quarter earnings season. They also chatted about recent market performance and the outlook for economies and markets amid the spread of the delta variant of COVID-19.
U.S. unemployment claims rise. Are routine factory shutdowns to blame?
U.S. weekly initial jobless claims unexpectedly rose for the week ending July 17, Roach said, climbing to 419,000 and exceeding consensus expectations. While the uptick may have appeared slightly concerning on the surface, a deeper probe into the data shows that the increase in claims was concentrated among a select few states, she noted.
"Most of the rise in unemployment claims came from states like Michigan, Kentucky and Texas, due to regularly scheduled summer shutdowns of auto manufacturing plants," she explained, adding that new jobless claims actually fell in 30 other states. In addition, the number of continuing unemployment claims nationwide has been in a steady decline for the last several weeks, Roach said.
Meanwhile, a slew of flash PMI (purchasing managers' index) surveys from July showed mixed results for the global economy, she noted, with manufacturing activity beating expectations in the U.S. and the eurozone, while declining notably in the UK. On the services side, activity weakened in both the U.S. and the UK, but strengthened in the eurozone, with IHS Markit's flash PMI for the region climbing to a level of 60.4, Roach said.
"Overall, these early estimates of business activity in July suggest that the eurozone is on strong footing, with the softer readings in the UK likely indicative of the impacts of the surge in infections caused by the delta variant," she remarked.
Q2 earnings season off to strong start
Turning to second-quarter earnings season, where approximately 100 of U.S. S&P 500 companies have reported results so far, Roach noted that expectations for year-over-year growth for the second quarter of 2021 are very high. "The consensus forecast among analysts calls for revenue growth of over 20%, and earnings growth of nearly 70%," she noted.
So far, the results have been impressive, Roach said, with roughly 85% of reporting companies beating expectations by about 18%. "This is a very encouraging sign that the above-trend growth we saw in the first quarter of the year will continue - likely through the remainder of the year," she stated.
Roach said that the strong start to second-quarter earnings season has revealed three broader themes pertaining to earnings growth, the first of which is that value stocks are expected to handily beat growth stocks. "Value stocks are likely to substantially outpace the earnings growth of growth stocks by a factor of over two to one," she stated, "and I believe this is something that will persist for the remainder of the year, due to the much higher growth rates in pro-cyclical sectors such as energy, materials and financials."
Another theme from second-quarter earnings season is the expected growth in small cap companies in comparison to large cap companies, Roach said, explaining that small cap companies are expected to report, on average, growth of over 200% on a year-over-year basis. She added that it's too early too say whether these extremely high growth expectations will be met, as most small cap companies haven't reported results yet.
The third theme emerging from the current earnings season is that European companies are likely to surpass their U.S. counterparts in growth, Roach said. "So far, European companies have reported year-over-year earnings growth of 84%, compared to 70% for S&P 500 companies," she noted.
All in all, second-quarter earnings season is off to a very strong start, Roach concluded, with the results so far helping reinforce the strong rally that's occurred in markets over the past 12 months.
Two factors behind the July 19 selloff in equity and oil markets
The strong earnings season results helped drive markets higher by the end of the week of July 19, Roach said, with the S&P 500® Index up nearly 2% as of midday Pacific time on July 23. However, the week started off on a rough note, she remarked, with global equity markets dropping approximately 2%, the yield on the 10-year U.S. Treasury note sinking to a five-month low and the price for a barrel of U.S. West Texas Intermediate crude oil falling below $70.
"The primary driver of this risk-off event was news around the spread of the delta variant, which made investors nervous that the economic recovery could be delayed or derailed," Roach explained. She added that at the same time, news broke that members of OPEC+ (the Organisation of Petroleum Exporting Countries, plus other major oil-producing nations) had reached an agreement to boost the supply of oil, which led to investor concerns that the rise in COVID-19 infections could hamper global demand for oil.
As the week progressed, market fears were soothed by a wave of strong earnings reports, in addition to a statement from the European Central Bank reaffirming its commitment to maintaining an ultra-accommodative monetary policy for a longer period of time, Roach said. Ultimately, this all combined to bring Treasury yields, oil prices and equity markets back to the previous week's levels, she noted.
Outlook for markets as delta variant spreads
Roach and Bardewyck wrapped up the segment with a look at how the spread of the delta variant could impact markets and economies. "From an investment perspective, we don't believe that the increase in COVID-19 infections is a cycle-changing event - especially in developed markets like the U.S. and the UK, where vaccines have proven to be highly effective at keeping hospitalisations and death rates low," Roach stated. In her opinion, things still look to be on track for above-trend growth that can support current market valuations.
That said, Roach noted that market sentiment could certainly turn volatile in the short-term, especially as investors grapple with an uneven decline in COVID-19 infections, shifting unemployment numbers and the ongoing surge in inflation. "Additional bouts of volatility will continue to be possible over the next several months, but overall, I believe the environment will be favourable for risk assets, given the globally accommodative monetary policy and the robust corporate growth fundamentals we've seen so far this quarter," she concluded.