How the ASX Can Benefit from a Poor Earnings Season in the US

Australia’s financial reporting season may be over, but a new one is kicking off in the US.

Over the next month, US companies will begin announcing their annual profits. By November 6, over 85% of S&P500 listed companies will have publicised results.

Without question, this is a key month for global markets. So what should you be concerned about in the month ahead? Two things in particular stand out.

One is what actual earnings reports say about the health of US companies. If earnings growth slumps across the board, it only adds to fears markets surrounding the state of the global economy.

What might this mean for the ASX? In the event of falling US profits, the local share market won’t get off lightly. That’s because the US is a reference point for global investors. Markets rise and fall in tandem with movements on US stocks. And the ASX is no different in that respect.

What can you expect from the upcoming earnings season? Well, there’s both good and bad news.

Right now, analysts aren’t optimistic about the month ahead. The concern is that the earnings season develops into a full blow ‘earnings recession’. In other words, a month of nothing but falling earnings growth reports.

It may signal that the US economy is even closer to a recession than many think. How? An earnings recession works much the same as an economic one. Only with earnings, companies must report two quarters of negative earnings per share (EPS) growth.

If you take experts on their word, the outlook for US company earnings is grim. Number crunchers forecast third quarter EPS falling by 4% across the S&P500. That would be the first consecutive quarter decline since 2009.

Yet some dismiss EPS forecasts altogether. That’s because they’re not reliable as a gauge of actual earnings performance. As far as theories go, it’s a pretty convincing one. EPS across US stocks have beaten forecasts in each of the past 25 quarters. That’s not an anomaly…it’s a trend.

Before panicking about a US economic recession then, consider the historical difference between what markets expect and what they get. What’s more, Wall Street has good reason to downplay EPS forecasts. It’s a simple enough motive.

You first temper investor expectations. You make them think earnings will undershoot company targets. Then you stand back and watch investors jump for joy when results ‘beat’ expectations. It’s an old trick, but one that never fails to work.

Watch out for non-energy sectors on US markets

Nonetheless, tracking US earnings season results will be important. Particularly in the context of all the recent volatility on global markets. Slowing growth, commodity price falls, and current movements have all added to economic uncertainty.

Keep an eye out on the non-energy sector in particular.

Bank of American Merrill Lynch estimates earnings across the energy sector plunging by 60%. Yet if you remove energy stocks from the equation, total earnings on the S&P500 could rise by 3%.

We already know, that energy companies will report poor earnings growth. The commodity rout, particularly in oil, will leave many US energy companies vulnerable. But that’s why you should focus on the rest of the market instead of the overall earnings results.

Ask yourself: is there an earnings recession in non-energy stocks? If not, then there’s not much to worry about. Upbeat profits across other sectors should ease fears in the US and global anxiety about the world economy too.

On the other hand, meagre earnings in these sectors could suggest worse to come. That would be damaging not only to US stocks, but global markets too. With slowing growth in China and Germany, the world is looking to the US for some good news.

Either way, earnings seasons will test the resolve of global markets. And it comes in the wake of a rally that’s seen the value of global stocks rise by $2.5 trillion. Global stocks recently bounced back from their worst quarter since 2011.

Ahead of earnings season, the S&P500 is up 35 points since last Tuesday. The index has climbed back above 2,000 to 2,014. The ASX followed US markets up last week, finishing on 5,274 points. These gains were partly down to a rally in resource stocks.

Yet Aussie investors were second guessing this recovery on early Monday morning. The ASX is down 40 points, to 5,240 as of 11:00am AEST.

Woodside [ASX:WPL] is down 1.5%. Santos [ASX:STO] is trading 2.9% lower. Origin Energy [ASX:ORG] is down by 5%, to $6.20 a share.

But the resource recovery is only a temporary mover of markets. The one constant that hasn’t changed is global interest rate policy, led by the US Fed. And the present low interest rate environment shows no signs of changing soon.

Keeping rates on hold was an admission by the Fed of the troubles facing the global economy. It feared what a policy reversal might do to any potential recovery. Yet all of this is great for stock markets. Loose credit policies are key drivers of rising assets like stocks.

US earnings season and the ASX

I mentioned earlier that US earnings will impact the ASX too. The direction the ASX takes in the coming weeks will likely follow US stocks closely. If companies report better than expected earnings, markets will bounce upwards. Not least because it gives investors something to hold onto amid fears over global economic growth.

But there could be a positive spin for the ASX —even if the S&P500 falls below expectations.

It comes back to US interest rates again. Poor earnings would lower the likelihood of US interest rates reversing anytime soon. Two straight quarters of falling EPS suggests a possible future recession. Knowing that, what does it say about rising rates? In an economy teetering on the edge of recession, it’s the last thing the Fed would do.

Regardless, the problems facing the US economy haven’t gone away. Even if earnings season provides a lift for stocks, three issues will continue weighing on markets. These are the same three problems dragging on global growth: US interest rates, weak commodity prices, and slowing emerging market growth.

For now, US rates aren’t an issue. That should provide some level of stability to global markets. But even if the US earnings season boosts stocks, it may only be a brief rally. There’s still the worry of a shaky global economy to think about…

Mat Spasic,

Contributor, Markets and Money

PS: The Aussie share market has lost 5% since June, or more than $90 billion in value.

Markets and Money’s Vern Gowdie saw this coming. He predicted the current market correction at the beginning of the year. But Vern says we haven’t seen the worst of it yet.

He’s convinced the ASX will lose as much as 90% of its market cap in the coming months. As China’s economic slowdown picks up pace, volatility will follow.

Vern is the award-winning Founder of the Gowdie Family Wealth and The Gowdie Letter advisory services. He’s ranked as one of Australia’s Top 50 financial planners.

Vern wants to help you avoid this coming wealth destruction. That’s why he’s written this free report ‘Five Fatal Stocks You Must Sell Now’. As a bonus, Vern will show you which five blue chip Aussie companies could destroy your portfolio. You’ll be surprised to learn which banks make Vern’s list…

To find out how to download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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