Quote of the week
“That's what the Iron Bank is, a temple. We all live in its shadow, and almost none of us know it…If you owe them money, and you don't want to crumble yourself, you pay it back.” Tywin Lannister, from “Game of Thrones”
The Lead Story: What will U.S. companies do for an earnings encore?
Following 15% corporate earnings growth in the first quarter, expectations are running high as the second-quarter corporate earnings season kicks off in earnest the week of July 17. It’s common for analysts to revise down their earnings forecasts, only to see companies beat those lowered expectations. So far in 2017, this little game has not occurred—at least not to the same extent.
Current consensus expectations are for S&P 500 Index earnings growth to reach 7% versus a year ago. We expect this figure to be helped considerably by an outsized contribution from Energy companies, which delivered poor earnings in the second quarter of 2016 amid plunging oil prices. Put another way, the high likelihood that Energy firms will outstrip forecasts will make it easier for the S&P 500 as a whole to clear the profitability bar.Without Energy, second-quarter S&P 500 earnings are forecast to grow by only 4%, but that seems low to us—we expect an 11% jump year-on-year (7% excluding Energy). This pace should be robust enough to support equity prices at their current levels. However, our long-held belief that market valuations already reflect improved earnings growth means an additional upward surprise (e.g., much better economic growth and/or significant retroactive tax reform) is necessary to propel index levels higher this year.
Current consensus expectations are for S&P 500 Index earnings growth to reach 7% versus a year ago. We expect this figure to be helped considerably by an outsized contribution from Energy companies, which delivered poor earnings in the second quarter of 2016 amid plunging oil prices. Put another way, the high likelihood that Energy firms will outstrip forecasts will make it easier for the S&P 500 as a whole to clear the profitability bar.
One aspect worth watching is overseas revenue growth for U.S. companies. As the U.S. economy surpassed the rest of the developed world and much of the emerging markets (EM) over the last few years, those U.S. firms with domestic customer bases benefited, while globally oriented U.S. companies struggled. More recently, however, with Europe strengthening and China rebounding, having an international customer base has once again become an asset. We expect earnings for companies in the Eurozone and broadly in EM to rise faster than in the U.S., as their revenues increase and balance sheets finally shake off the effects of the 2008 financial crisis.
In other news: Stocks and bonds both rally
With little economic data to digest, markets focused on Federal Reserve Chair Janet Yellen’s semi-annual testimony to Congress on July 13 and 14. Doves were not disappointed. Yellen signaled that the Fed will continue its patient approach to raising interest rates, while sounding a bit less confident that the current lack of inflationary pressure will be temporary, a view corroborated by June’s consumer price index report, released on July 14 (see below). In response, dollar bulls took it on the chin, as the greenback fell about 0.8% for the week versus a basket of foreign currencies.
In contrast, equity markets relished the possibility of “lower-for-longer” interest rates. The S&P 500 Index climbed about 1.4% for the week and finished at an all-time high. Europe’s STOXX 600 Index jumped 1.85% in local currency terms, with the dollar’s decline magnifying that gain to 2.1% for U.S.-based investors. EM stocks, which often benefit from dollar weakness, surged nearly 4% for the week through July 13 and have returned 22.3% year-to-date—more than double the 10.5% rise in the S&P 500.In fixed-income markets, U.S. Treasuries benefited from a combination of Yellen’s dovish testimony and June’s discouraging retail sales and inflation readings. The yield on the bellwether 10-year U.S. Treasury fell to 2.32% on July 14, just one week after it hit 2.39%, a two-month high. (Yield and price move in opposite directions.)
Results for non-Treasury sectors were positive. Inflows supported investment-grade corporate bonds, which returned 0.4% for the week through July 13. Although investors pulled money from high-yield corporate bond funds, the asset class realized a 0.3% gain, lifting its year-to-date return to over 5%.
Below the fold: Spenders aren’t spending, and inflation is scarcely inflatingInflation and retail sales data both provide key insights into the state of the U.S. economy. June’s reports disappointed on both fronts.
- Retail sales declined 0.2% (versus expectations for a 0.1% increase), their second consecutive monthly drop.
- The Consumer Price Index was unchanged. More importantly, prices rose just 1.6% compared to last June, a far cry from February’s year-over-year reading of 2.7%. Excluding the volatile food and energy categories, so-called “core” inflation increased just 0.1% last month and 1.7% from a year earlier.
- Consumer sentiment fell further from January’s 10-year high, according to the preliminary reading of the University of Michigan index. Consumers’ expectations of long-term future economic prospects continued to falter despite high confidence in the current state of affairs.
With central banks in focus during the past week and Season 7 of “Game of Thrones” set to air on July 16, let’s travel back in time. What might it have been like to deal with the Iron Bankers or various tax collectors centuries ago?
Back page: Finance lessons from Westeros and England
In England, taxes were assessed on landowners to pay for the king’s mercenaries. (As the Lannisters have discovered, financing wars is costly, particularly when your gold mines have run dry.) Peasant farmers had to pay a “tithe”—often as much as 10% of the value of the land—in the form of seeds or other agricultural commodities. This was an onerous obligation since they also had to pay rent to barons and landowners for the privilege of tilling the soil. Homeowners were often taxed on the number of windows and fireplaces in their houses, and there also were taxes on wool, soap, and playing cards.Interestingly, medieval Britons believed in debt-free living. Perhaps that’s why Tyrion Lannister is so fond of saying “A Lannister always pays his debts.”