The US third-quarter earnings season kicked off last week with a slew of key financial sector reports, including Citigroup, JPMorgan Chase and Wells Fargo. The overall take from the banks’ earnings is good bottom line numbers driven by strong overall activity and lower credit provisions. JPMorgan Chase’s shares were lower during the session as the bank missed expectations on revenue. In general we observe less investor optimism towards US banks despite interest rates going higher, which is an unusual behaviour.
US banks are technically weak and are down more than 10% from their peak in January, having touched fresh lows year-to-date last week. Our view is that tailwind from the US tax reform, rising US interest rates and external weakness will drive lower earnings growth going forward with earnings peaking here in Q3/Q4. As we have outlined in our Q4 Outlook we are underweight US equities as they are too expensive against all other equity markets.
US sales growth is peaking: In Q2, the S&P 500 companies printed their best sales growth y/y since the Great Financial Crisis at 9.4% y/y. Based on the Q3 figures so far the growth rate is lower but it’s too early to say as only 28 companies have reported Q3 earnings in the S&P 500. Given the strong US economic activity figures we expect sales growth to remain strong going into Q3/Q4 but then decline as several headwinds will hit US companies in 2019 from rising interest rates, weak external environment in emerging markets, strong US dollarand no impulse from the tax reform. As we have been arguing for over the past months US equities are expensive relative to global equities as their valuation reflects high expectations that will likely not be met in 2019.
We hear a lot that EPS growth is phenomenal but that’s an unreliable indicator due to the Trump administration’s tax reform. The EBITDA (operating income) figure is more stable and stripped from one-off items, EBITDA growth has declined since Q2 2017 from 16.1% y/y to 8.7% in Q2 2018 as the impulse on energy earnings has disappeared.
We expect tariffs that have emerged from the ongoing US-China trade war will begin to have a negative impact on EBITDA growth and margin.
Earnings releases heating up: Next week 120 companies will report Q3 earnings with the majority being US companies. Of these 120 companies the three companies below are the most critical to watch in relation to the global economy and current developments.
Netflix: the world-leading video streaming company is set to report (after the close) with analysts expecting EPS $0.80, up 106% y/y as costs are no longer growing rapidly compared to revenue, which is expected to grow 34% y/y as the company’s international expansion continues to fuel growth. While investors still believe in the investment case,
Netflix’s international expansion continues to put strain on cash flow generation, which was negative from operations in the past 12 months. Netflix’s Q3 earnings are important for sentiment on technology stocks that have been increasingly under pressure lately.
ASML: the Dutch-based semiconductor company is set to report Q3 earnings today (before the open) with analysts expecting EPS €1.58 up 18% y/y and revenue up 13%. Why is ASML’s earnings important to watch? Because earnings among semiconductors have been phenomenal over the past two years with earnings up 80% in two years.
We expect semiconductors to be vulnerable to the ongoing US-China trade war and pricing pressure could slow earnings growth.
We have an underweight rating on semiconductors. A slowdown in semiconductor earnings is also a leading indicator on the economy.
American Express: consumer spending is driven by credit and American Express has always been a good leading indicator of the US economy and consumer spending. The company reports Q3 earnings on Thursday (after the close) with analysts expecting EPS $1.76, up 18% y/y, and revenue 19% higher y/y.
Any signs from management that credit is slowing is important information for investors in gauging where the US economy is headed.
Peter Garnry is head of equity strategy at Saxo Bank.
