The much anticipated, late-August calm in financial markets has taken a backseat amidst rising geopolitical concerns, increased uneasiness in response to the rhetoric from Washington and a few weaker-than-expected earnings releases in the week ending 18/08/17.
After a strong first quarter earnings season in the US, overall results for the second quarter, so far, is also better-than-expected, with mid-single digit top line growth and earnings growth almost doubling that of revenue. We are seeing margin expansion in the most cyclical companies and as long as revenue growth continues and wage pressures remain muted, profit and profit margin expansion should persist in the near term.
As global growth increases, US companies with larger international exposure are increasing earnings at a faster pace than their domestic only peers. The European region is seeing stronger economic growth than many anticipated heading into the year, and the Japanese economy expanded its growth streak during the second quarter, while the picture in Latin America remains mixed.
We expect earnings to benefit from currency translation gains in the second half of 2017. Leverage for US corporates remains elevated and the much anticipated pickup in capital expenditures is not materializing. Based on a recent Standard & Poor’s survey of corporate issuers, North American companies are expected to increase 2017 capital expenditures by 3.5% over 2016. While the trend is better than recent years, it is underwhelming, and with the expectation for meaningful tax reform fading, along with reduced outlook for energy prices, 2018 capital expenditure budgets may be lowered as well.
Absent any major shocks, many economists expect the US economic expansion to continue for the next 12-18 months. If it does it could become the longest on record.
However, events (the tense standoff between the US and North Korea, domestic events involving President Trump’s declarations) in the first half of August weeks have created some angst in markets (see Exhibit 1 below), especially for the riskier assets. Equities and high yield bonds saw outflows during the week ending 18/08/17, as investors flooded to traditional safe havens.
Exhibit 1: The recent rise in the VIX index reflects market angst over geopolitical risks (graphs shows changes in the Chicago Board of Trade Options Exchange SPX Volatility Index for the period from February 2017 through to 18 August 17)
Source: Bloomberg, BNP Paribas Asset Management, as of 18/08/2017
US economic data released during the week ending 18/08/17, while mixed, is largely supportive of continued growth in early third quarter. The 0.6% gain in retail sales in July and upward revisions in May and June, showed an accelerating consumer demand in the third quarter 2017. The strength in retail was broad based, with even the department stores, in secular decline, posting growth. Total business inventories increased by 0.5% in June, also signalling a slight upward revision to second quarter GDP data. US Industrial Production and Capacity Utilization data came in positive during July, with Industrial Production up 0.2% and Capacity Utilization up 0.1% sequentially.
US homebuilding data was mixed. Housing starts and building permits were below expectations, while homebuilder confidence increased, ahead of expectations, and may be indicative of the difficulties that builders face in finding suitable land.
From a fundamental perspective, the current cyclical backdrop remains supportive for U.S. earnings growth in the second half of 2017, and consumption data started off the third quarter on a strong footing. With a strong job market and household wealth at record levels, the favourable consumer indicators remain supportive to the U.S. economic growth narrative. However, a deteriorating political situation could raise uncertainties in the second half of 2017.
Written on 22/08/2017