Three quick ways to measure the second-quarter results season in America

For all of President Trump’s tax cuts, a share buyback and acquisition bonanza and ongoing enthusiasm for tech stocks and the FAANGs in particular, America’s headline S&P 500 index is up by just 2% for the year in dollar terms, which some advisers could argue seems like a pretty paltry return given how bullish everyone seems to be.

Worries over tariffs, inflation and a steely Federal Reserve, which seems unwilling (quite rightly) to mollycoddle the markets, are all weighing on share prices and once Independence Day is out of the way investors will start to focus on the second-quarter earnings season. The revs will really start to hit top gear on Friday 13 when megabanks JP Morgan Chase, Citigroup and Wells Fargo will publish their latest earnings.

Hopes for strong profits growth helped to fuel the S&P 500’s strong advance in late 2017 and early 2018 as analysts factored the Trump corporate tax cuts into their estimates.

After 20% year-on-year growth in Q1, the consensus is looking for a 38% advance in Q2, buoyed by tax cuts, share buybacks, initial dollar weakness and also a strong operational performance from oil and tech firms in particular.

Analysts are looking for another big year-on-year leap in US earnings in Q2

Source: Standard & Poor's

Estimates have crept consistently higher but the dollar is now rising again – which will lessen the value of profits made outside the US once translated back into the American currency – and surveys such as the ISM purchasing managers’ survey, NFIB smaller business optimism index and the NAHB housebuilders’ sentiment survey are all flagging future price rises or cost pressures, with some identifying the President’s trade sanctions and tariffs as the root cause of this trend.

Analysts have continued to upgrade their US earnings forecasts in 2018

Source: Standard & Poor's

US stocks trade near all-time highs and it is easy to see why, since profits are at an all-time high and so are operating margins across the S&P 500’s members.

Flood of figures

But that also means growth forecasts must be met and margins maintained or increased to keep stocks going ever-higher. It will therefore be interesting to see if any US firms flag any negative impact from tariffs, costs or the dollar, as any disappointments could be poorly received. No-one is expecting a 2008-09 style margin collapse but with US stocks having done so well even a dip in corporate returns on sales may not be received too well.

Aggregate profit margins at the members of the S&P 500 are near record highs again

Source: Standard & Poor’s

However, checking all of the results statements is too laborious a chore for any adviser or client: 61 members of the S&P 500 will report in the week beginning 16 July, 183 more in the week of 23 July and 144 in the week of 30 July, according to Standard & Poor’s.

To spare advisers and clients from reading a lot of statements and listening to a lot of webcasts, three useful stock indices might help to cut out some of the donkey work and help to take markets’ temperature as the numbers flood in.

Three tests

They are the Dow Jones Transportation index, the Philadelphia Semiconductor index (known as the SOX) and the Philadelphia Banks index. They tap into three key sectors of the US economy and stock markets and tend to be good indicators of wider sentiment – while the past is by no means guaranteed to repeat itself, the S&P 500 tends to do well when they are doing well and badly when they are doing badly.

  • Transports

    It is of some concern to see the Dow Jones Transportation index roll over. It is now down 1.5% for the year, compared to the 2.0% gain in the S&P 500.

This does not sit easily with estimates for 3.5% to 4.0% GDP growth for the USA in the second quarter but stock markets look forwards, not backwards, and the implication may be that America may not be able to win any trade war or keep growing at such a speed independently of events across the rest of the world in the future.

US transport stocks seem to be losing a bit of steam

Source: Thomson Reuters Datastream

  • Chips

    The Philadelphia Semiconductor index, or SOX, contains 30 companies who are involved in the design, manufacture and sale of silicon chips and it is therefore a very useful guide for investors on two counts.
  1. These integrated circuits are everywhere, from smart phones to computers to cars to robots, so they offer a great insight into end demand across a huge range of industries and therefore the global economy.
  2. Chip-makers’ and chip-equipment makers’ shares are generally seen as momentum plays, where earnings growth is highly prized and valuation less of a consideration. As such they can be a good guide to broader market appetite for risk.

Silicon chip index looks a little soggier than of late

Source: Thomson Reuters Datastream

It is therefore disconcerting to see index member and DRAM manufacturer Micron take a pasting even after its quarterly numbers in June beat expectations, to suggest that at best the chipmakers are taking a breather after a strong run and at worst looking overbought and overvalued.

The whole index has sagged a little and Intel’s numbers on 26 July – and the market’s reaction to them – could be a key test.

  • Banks

    American banks stocks suffered a shocking run at the end of June as investors nervously awaited the latest Federal Reserve stress tests. Deutsche Bank’s US operations failed and others, notably Goldman Sachs and Morgan Stanley, were told to leave dividends and buybacks broadly unchanged so they could top up their capital buffers.

US banks stocks have lost a little lustre

Source: Thomson Reuters Datastream

But it could have been a lot worse so perhaps the banks will now kick on again. Both the economy and the financial markets do need healthy banks if they are to thrive so any further weakness in the Philadelphia Banks index could warn of economic and market troubles ahead – the sector lost momentum well before indices such as the S&P 500 in early 2007, before the Great Financial Crisis broke.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.