What’s the early read on Q2 earnings season?

On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Research Analyst Laura Bardewyck reviewed early results from second-quarter earnings season. They also discussed the European Central Bank (ECB)’s first rate hike in 11 years, as well as the latest developments surrounding the energy crisis in Europe.

Is Q2 earnings season shaping up better than expected?

Eitelman said that with the U.S. economy slowing down as the Federal Reserve (Fed) attempts to bring inflation under control, the health of the nation’s corporate sector has become an important watchpoint for markets. This makes second-quarter earnings season rather important, he noted, for clues into whether the Fed’s series of aggressive rate hikes will bend or break the U.S. economy.

So, what do the latest results suggest? While it’s still very early in the reporting season, Eitelman said that the initial results generally look OK. He noted that a few of the bigger S&P 500 companies, like Tesla and Netflix, reported results the week of 18 July that topped analysts’ expectations. "Tesla had some production issues last quarter due to COVID-19 lockdowns in Shanghai, but still delivered better earnings than Wall Street was looking for. Meanwhile, Netflix, which has struggled this year, actually lost less subscribers than feared," he said.

Ultimately, against a rather low bar, recent earnings news has been a little bit better than expected, Eitelman stated, noting that the results helped contribute to some recent positivity in financial markets. As proof, he pointed to the S&P 500® Index, which was up approximately 3.5% the week of 18 July, as of market close on 21 July. The recent gains in the U.S. equity benchmark have helped pull the index up nearly 9% from its mid-June lows, he noted.

"There’s been a lot of pessimism in the market, and while there are certainly some big macroeconomic risks out there, the latest numbers from second-quarter earnings season have at least been a little less bad than anticipated," Eitelman concluded.

ECB surprises markets with half-percentage-point rate increase

Shifting to Europe, Bardewyck noted that on 21 July, the ECB raised borrowing costs for the first time in 11 years in a bid to quash inflation, lifting its key rate to zero. Eitelman added that the 50-basis-point increase, the central bank’s steepest rate hike since 2000, surprised markets, which had been anticipating an increase of 25 basis points. "This hike also moves interest rates in Europe out of negative territory for the first time in eight years," he remarked.

In addition to the rate increase, the ECB also announced the creation of a new policy tool, known as the Transmission Protection Instrument (TPI), Eitelman said. The purpose of the tool, he explained, will be to try to protect eurozone nations with higher debt, such as Italy, by ensuring that each of the bloc’s 19 member states experiences the same monetary policy. The tool should effectively contain interest-rate spreads between member states, he said, such as the closely watched gap between the yield on the 10-year Italian bond and the 10-year German bond.

"Importantly, there’s basically no limits as to how much money the ECB can put behind this tool, which I see as an important positive step for the bloc’s monetary policy framework over the medium-term," he stated.

Russia restarts Nord Stream pipeline

Bardewyck and Eitelman concluded their conversation with a look at the energy-supply crisis in Europe, which has intensified since Russian President Vladimir Putin began his assault on Ukraine in late February. Eitelman said that the Nord Stream pipeline, which sends natural gas from Russia to Europe, was restarted on 21 July, following a 10-day shutdown for maintenance.

"Markets had been concerned that Russia might not turn the gas flows from the pipeline back on due to tensions around the war in Ukraine," he remarked, characterizing the resumption of gas supplies to Europe as incrementally positive news. "Had there been an abrupt cutoff in gas flows, that would have presented some meaningful challenges for Europe," Eitelman said, noting that the pipeline is currently flowing at around 40% capacity - the same level it was at before being shut down for maintenance. However, with natural gas prices in Europe still remaining very high relative to a few years ago, the economic situation in the region remains fraught, he concluded. 

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