Where are earnings coming from and where are they heading?

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Corporate earnings and the rate of growth of the service economy are two key macro indicators

Mixed data continues to send mixed messages; but broad agreement that there’s macro risk

Marcus Reubenstein

The old adage, if you want three different opinions on the state of the economy just ask two economists is holding true in the current market. The consistent theme is that downside risks are there for developed economies, thus the global economy. Many analysts are keeping an eye on the services sector, which is just managing to buck the downward trend of a fall in manufacturing, and on corporate earnings.

On Wall Street, as of last week, 15% of the companies in the S&P 500 had reported results, with 84% posting positive earnings surprises and 64% had reported positive sales surprises. With little movement in the major indices most traders are calling the early results a mixed bag.

Sam Stovall, chief investment strategist at CFRA, told the Associated Press, “Fewer than a quarter of the companies have reported, so there’s a lot more to come; but the results have been mixed so far, even with the bar being set as low as it was.”

Australia’s earnings season wrapped up two months ago, of that, Michael McCarthy Chief Market Strategist at CMC Markets says, “Overall growth was moderate. However, the performance of sectors and individual companies varied wildly within this modest outcome. Consumer services stocks reported a decline in sales of 12%, leading to a drop in earnings across the sector of around 25%. Although Telco sales decreased by less than 1%, profits fell 40% as major players cleared the decks.

“In contrast, other sectors saw double digit sales growth. Healthcare, consumer goods, financials and technology stocks outperformed. The basic materials and technology sectors grew earnings at rates close to 30%. These are stunning returns in light of the market-wide average.”

According to Bloomberg, of 1,200 Chinese listed companies which had announced their profit guidance by the end of last week, 44% were expecting an earnings decline; more than half expected earnings to improve or remain unchanged.  

As recently as a decade ago, China was still regarded as the world’s factory, Ministry of Commerce data points to a service economy take over. In 2018, services made up 52.2% of GDP with an annual growth rate of 11.5%.

But Stuart Dear, Deputy Head of Fixed Income at asset managers Schroders, sees risk in the services sector, “The slowdown that we’ve seen in the global economy over the last twelve months has been largely driven by a slowdown in manufacturing related to the trade war, in particular. While we’re watching that closely, I think probably the more important thing is whether that spills over then into the service parts of the key economies.”

Last month saw an unexpected contraction in the UK services, which can partly be blamed on the Brexit mess; Germany’s services sector continues to grow, albeit it at the slowest pace in five years.

In the past ten years the US PMI Services Index has only dipped below 50 (the negative growth value) twice, in late 2013 and early 2016. The index is now hovering closer to negative territory than its been at any time in the past three years.

“A disappointing service sector PMI follows news of lacklustre manufacturing and means the past two months have seen one of the weakest back-to-back expansions of business activity since 2009, sending a signal of slower GDP growth in the third quarter,” says Chris Williamson, chief business economist for IHS Markit.

“The surveys are consistent with the economy growing at a 1.5% annualised rate in the third quarter, with forward-looking indicators suggesting further momentum could be lost in the fourth quarter.”

Stuart Dear, of Schroders, marks this down as a key indicator, “I think this question about whether we get the spillover from manufacturing in services is pretty critical. If we do get that, then you probably see that time frame pull forward, it’s probable that the US tips into recession earlier if we do get that, that spillover.”

Says Michael McCarthy of CMC Markets, “The services sector in Australia is affected by sentiment, the ongoing conservatism of consumers will see subdued growth. Right now that slowdown in confidence is being fuelled by uncertainty. If Beijing and Washington DC can resolve their differences that will be helpful in lifting confidence.”