This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, James Butterfill, global equity strategist at Coutts says US profits to beat low-ball forecasts.
With the US summer earnings season about to kick off, the signs so far suggest results will beat low-ball estimates, supporting our view that equities will make modest gains this year and outperform bonds.
Of the 70 companies that have reported third-quarter results so far, 60% have beaten expectations, which – as usual – were downgraded by analysts in the run-up to the reporting season. This negativity may have been caused by economic data generally missing expectations. The tech sector has seen 16 out of 17 companies beat expectations while the discretionary sector has been a little more disappointing with 13 beats and 14 misses.
We expect growth in net income compared to the previous quarter, and for results to beat expectations for the market as a whole. We also expect net income growth compared to the previous quarter. This will in part be due to a recovery in energy-intensive companies’ earnings after high natural gas prices over the winter period that weighed on profits in the last quarter. A recovery in earnings is also likely due to generally lower input prices for many companies. What’s more, purchasing managers’ indices (PMIs) of business activity suggest corporate confidence remains unfazed by speculation that an interest-rate hike may come sooner than expected.
US equities have typically been supported when results beat expectations, and we expect this to still to be the case. However, due to high US valuations and the greater recovery potential in European earnings, we remain underweight the US and overweight in Europe, while also remaining overweight equities in general relative to bonds.
Europe Downgraded Too
Second-quarter earnings estimates have similarly been lowered in Europe, which we believe to be unjustified. Indeed, we believe there is potential for earnings growth to match high expectations in the periphery, particularly in Italy where earnings would be growing from a low base.
And despite the downgrading of estimates for this quarter, analysts have been upgrading their growth expectations for the full year as the economy shows signs of gradual recovery. Rising capital expenditure further supports expectations of earnings growth.
PMIs continue to improve in peripheral countries such as Spain and Italy, our preferred equity markets in Europe, while they are rolling over in the core countries of Germany and France.
As in the US, the industrials sector took a hit from rising input prices, although gas prices have since stabilised and input prices remain accommodative for manufacturers in general. The prospects of further weakness in the euro are also likely to support earnings in a region where 55% of revenues are sourced from abroad.
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