Global Equities: How US earnings are likely to land

Earnings season is getting underway in the US. Senior global equities analyst SUE SCOTT outlines what investors can expect this quarter

• US Q3 earnings have kicked off
• Post-Covid adjustment still playing through earnings
• Find out about Pendal Concentrated Global Share Fund

COMPANY earnings in the US are likely to cause further market volatility this quarter as investors try to understand how the post-Covid economy is adapting to higher interest rates.

Next week investors will start to get a good look at how US companies fared in the September quarter – and expectations are low.

“There’s no doubt operating conditions remain very, very challenging,” says Sue Scott, a senior investment analyst with Pendal’s concentrated global share strategy team.

“We expect continued volatility. This is partly because the market is finding it very difficult to determine the extent to which a reversal of Covid spending is affecting operating conditions.

“There is also uncertainty around how much interest rates and inflation are affecting the environment.”

Last quarter’s earnings were characterised by cautious commentary about the outlook as management teams focused on cost containment.

A rising US dollar was just starting to emerge as a headwind, particularly for US-based global companies. But there was anecdotal feedback that demand remained resilient.

Shares ended the quarter broadly where they started, trading at about 15 times expected  earnings.

“But that’s only useful if you believe the ‘E’ in the price to earnings ratio,” says Scott. “That’s the big debate.

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“The market is still expecting growth — both in the third quarter and in 2023.

“But the real difficulty for investors is making sense of conflicting data points.”

Conflicting data

Over the past three months, US interest rates have continued to rise, the US dollar has hit 20-year highs, oil prices have fallen and commodities have weakened.

“You’ve also had Russia and Ukraine continue to escalate tensions, China-US tensions continue to simmer, further reports of US export restrictions to China particularly in technology, China Covid lock-downs continuing and poor economic data coming out of China.”

The rebuilding of supply chains and a shift in post-Covid consumer demand is also muddying the picture.

This is evident in out-of-cycle results that have come in before the bulk of the earnings season gets underway, says Scott.

“What’s confusing for investors now is that companies are reporting numbers that could reflect deteriorating consumer health or could just be a reflection of some of the dislocation in global trade and spending patterns as a result of Covid starting to normalise.”

“Nike — one of the bellwethers of the US market — said earnings disappointed for the third quarter because of lower margins due to discounting of out-of-season inventory caught up in shipment delays.

“So it was not so much about a weak consumer, but Covid-related logistic challenges.

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“We also know the personal computer market was overheated because everyone was working from home and kids were home-schooled.

“But it’s hard to distinguish if current weakness is due to normalisation of an over-heated market – or because interest rates are going up and people are spending less.

“Same with FedEx. They delivered a below-expectation result citing consumer spending shifting back to services from goods.

“As a result of all that, we’ve had consensus forecasts since the end of June revised lower for the third quarter by mid-single digits.”

Consensus estimates for 2023 have also been revised lower by a similar amount.

Scott says these effects are temporary and “we don’t necessarily see them as a massive red flag for the economy.

“But they are going to take some time to play out.

“Average global shipping rates fell 30 per cent in September, which is 60 per cent lower than they were a year ago. But that’s still 170 per cent higher than pre-Covid.”

Impact of the strong dollar

One of the big stories will be the impact of the higher US dollar, says Scott.

“More than 30 per cent of S&P company revenue comes from outside the US, and for some of the big tech companies, it’s more like 50 per cent.”

She says many companies in the sector have been softening up investors for a weaker quarter with talk of a pause in hiring, redundancies or restructures.

“We think some pockets of the technology sector are still very expensive and there is an outsized risk for earnings disappointment.”

But recent presentations from bank CEOs are painting a more optimistic picture.

“The underlying consumer-facing banks business is holding up very well and capital positions are strong.

“They’re benefiting from higher net interest income as a result of lending rates leading deposit rates higher and loan losses are reasonably benign.

“So far they’re not seeing any major signals of a deterioration in consumer activity. And even if they do, the balance sheet of the consumer is in much better shape than it has been historically.”

“Yes, spending patterns are changing away from goods to services — but there’s no real red flags from the banks.”