Market Update 13th May 2024

What is good news?

The first quarter results season has been an interesting one.

According to Factset, with in excess of 90% large American businesses having reported, more than three quarters have delivered better than expected results. That’s obviously encouraging, even when we factor in that the real benchmark for US companies is actually slightly higher than the published consensus. Generally in a reporting cycle, 70-something percent of businesses beat forecasts. This might seem confusing, but the best analogy I can think of here is that you’d expect the majority of pro golfers to post scores well under par in a tournament.

Part of this is because investor relations teams endeavour to drag the bar down to a beatable level, to allow a higher chance that the reported numbers exceed forecasts. For this reason, we should not be surprised to see that the majority (58%) of businesses that have issued forecasts for Q2 have done so at levels below prevailing expectations. The cat and mouse within forecast setting is just another reason to listen to what companies are saying about conditions, rather than just look at whether they have posted higher or lower forecasts.

The banks and payment processors are always a good place to start, since they have insight on spending and default levels across a range of sectors. Expected Credit Losses at the major banks are reasonable, and processed transactions, both by dollar value and volume, are healthy. Or in plain English, generally, they think the consumer is OK. That said, we have had our heads turned by some businesses plugged into the consumer talking of a more challenging US consumer outlook – including several with outstanding longer term track records. McDonalds, Starbucks, Disney and Lululemon to name just a few. May has also brought weak labour market data in the form of lower than expected growth in both hiring and pay.

The silver lining here is that this is exactly what the Federal Reserve needs to see in order to cut interest rates. The major US indices were actually all up strongly on the back of the labour market data mentioned above missing expectations. That’s because weaker growth reduces inflationary pressure, and helps pave the way for rate cuts. In turn, lower rates indicate higher consumer spending power in the future, and favourable discount rates (which feed into valuation models) now. So, bad news can be good news.

As we know, the US market continues to be dominated by big tech. Thankfully, given the slightly counter-intuitive dynamic above, the main themes in this sector have been crystal clear. Earnings momentum remains strong, returns to shareholders continue to be a major focus and  capital expenditure on AI and related technology is still ramping up significantly. Alphabet, which beat earnings forecasts, before announcing another buyback, a maiden dividend and a multi-billion capex plan, thus serves as a neat microcosm of the industry.

For share prices to retain momentum, investors have signalled they will need to see results from AI spending. Note how some of the gains Meta made in 2023 on the back of its market-friendly ‘year of efficiencies’ were reversed as it hiked spending, but wasn’t able to accurately quantify the payoff. This tells us that the market remains refreshingly rational. But if AI is the opportunity many, including senior leaders at all the tech groups, think it is, Meta’s spend has potential to reap significant rewards.

Closer to home, there are some green shoots on retail flows. After several negative months, UK retail investment flows into funds have turned positive again. In terms of catalysts, outflows linked to the impact the recent rate hikes had on the mortgage market have now likely run their course, and UK plc appears in reasonable shape.

Company balance sheets are generally being well managed, with leverage ratios below recent averages. A good earnings season has seen analyst forecasts for 2024 and 2025 edge up too, and further progress is now expected such that earnings per share in 2026 are projected to be  22% higher than what was reported in 2023. Of course, that growth is not guaranteed,  especially with the UK market geared towards commoditised markets like oil and gas, and metals and minerals. But from where we stand today, with earnings projections being increased rather than decreased, there’s no ambiguity – it’s a case of good news actually is good news.

Sentiment towards Europe also seems to be improving. Earnings momentum is strong here too, and the amount of money raised in new IPOs is at a three year high. Rates look likely to be cut in the summer as well, and there could be more dovish moves before the year is out.

Of course there could be trip wires ahead. But as we head towards a succession of significant elections across the world, we could be in worse shape.

George Salmon – Senior Investment Analyst

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