A house of cards about to collapse: The threat of Q2 corporate earnings to equity markets
Following the G20 summit over the weekend, markets gained over the week on the back of US-China trade optimism combined with optimism over a potential US rate cut in the face of weaker economic data. With little new information coming out of the G20 meeting apart from the resumption of US-China trade talks, investors remain in wait-and-see mode. Over the week, financial markets have been sending conflicting messages regarding investor sentiment, with equity markets gaining on the increased optimism over a trade resolution, while bond markets gained as yields fell, reflecting a spreading of risk-off sentiment in credit. At the same time, safe haven assets such as the US dollar and Gold gained, reflecting the increasing downside risks within the global economy.
Key takeaways from the G-20 summit:
• US-China trade talks have been resumed following a meeting between President Trump and President Xi. The US has agreed not to impose any new tariffs on Chinese exports while the talks are underway. China has agreed to resume broad purchases of American farm products and other goods, while the US has allowed companies to resume trading with Chinese telecoms giant Huawei
. • US tensions with Saudi Arabia were smoothed over (on the surface) following the murder of Mr Khashoggi last October. President Trump praised Crown Price Mohammed bin Salman for opening up his society and avoided questions about the Khashoggi issue, saying that “no-one blames” the crown prince. Saudi Arabia remains an important trading partner for the US.
• Climate change remains a core dispute among the G20 leaders as President Trump signalled that the US would withdraw from the Paris climate accord, and as President Macron threatened that France would not sign any joint statement unless it dealt with climate change. The final statement from the summit was essentially an agree-to-disagree approach. To the disappointment of climate activists, the G20 did not push for more aggressive targets. The next G20 meeting is to be held in Saudi Arabia in November 2020.
As the week went on, away from the G20 headlines, the economic data continued to disappoint, with global PMI data following a declining trend, illustrating economic weakness and the impact of trade tensions on key areas such as manufacturing. In the US, weaker construction spending, manufacturing activity and economic sentiment increased expectations for a rate cut in July. As the Fed continues to monitor the economic data for signs of weakness which may require an interest rate cut, non-farms labour market data is likely to provide an insight into the health of the US job market later this week following signs of potential weakness. As a strong job market has been an important factor in propping up the US economy over the first half of the year, any weakness would be significant and likely to weigh heavily on the Fed’s decision on whether to issue a rate cut in July.
Going forward, market movements are likely to focus on potential Fed interest rate cuts and corporate earnings expectations, with corporate earnings expected to take centre stage mid-way through the month as Q2 corporate earnings season officially begins.
For further information on the Q2 corporate earnings season and our expectations for the coming weeks, please see the attached Market Update document.
Overall, following a week of geopolitical headlines resulting from the G20 summit, little has changed in the economic landscape, with economic data continuing to decline over the month. US-China trade talks have been resumed as we expected, however this does not change the outlook, with no greater clarity or resolution in the tensions, with the two sides remaining far apart on key issues. As equity markets gain on sentiment, it is our view that earnings season could be the catalyst to bring about a decline in equity markets, following a series of downward reversions in earnings estimates and reduced expectations for a second half recovery in earnings. Given the risks facing the global economy, we remain defensively positioned with low exposure to equity markets given excessive volatility and increasing downside risks.
Key events this week:
• Thursday- Eurozone retail sales • Friday- US Non-Farms Payrolls (Labour market data)
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Over the week, global equity markets gained on the back of renewed optimism over US-China trade relations following the Trump-Xi meeting at the weekend. Interestingly, while equity markets gained following the trade truce, bond markets also rallied, suggesting that despite optimism over trade, risk
off sentiment is continuing to spread within credit markets as geopolitical tensions remain and as economic data continues to illustrate weakness in the global economy. It is clear that despite the USChina trade truce, risks are now tilted towards the downside, with economists warning investors not to get caught up in optimism when the sides remain far apart. As the OBI portfolios remain defensively positioned with limited equity exposure, our portfolios remained relatively flat over the week, with the defensive bar-bell within portfolios performing even as equity markets gain.
As we progress from here, it is important to recognise that we should not let benchmark performance make us feel like we have missed out on anything, because although we have in the short term, recent performance shows how quickly this can be reversed given current levels of risk and uncertainty. Overall, it is our view that markets will continue to fall over the coming months before adjusting to the new norm based on lower global growth and weaker corporate profitability. The key point here is to take a long-term view, look at the current level of uncertainty in the global economy, and remember that the portfolio is designed to minimise your exposure to risk and preserve capital.
As shown this week, the capital preservation strategy is designed to remain flat when equity markets display volatility, with a defensive tilt which means that when markets do decline, the portfolios are well positioned to benefit. Markets are behaving irrationally, therefore the most sensible strategy is a defensive one given current market conditions.
Important Information
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested.
Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1884, Dow Jones published its first stock index, the Dow Jones Transportation Average. It is the oldest US market index still in use, older than its better-known relative, the Down Jones Industrial Average. The index is a running average of the stock prices of 20 transportation corporations and was created by Chris Dow, co-founder of Dow Jones & Company.
Gina & Jason
