Global Weekly: Earnings season kicks-in

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Just before the second-quarter earnings season kicked-in this week, equity markets moved to higher levels. For the first time, the S&P 500 Index traded above 3,000. The broader Europe STOXX 600 Index also moved closer the its highest levels.

On a company basis, Amazon again reached a USD 1-trillion market cap. The only two companies reaching this enormous market cap are Microsoft and Amazon. Apple, however, is the one other company in the running. These three companies will present their second quarter results soon.

The US banks where among the first companies the report their earnings. The picture at JPM Morgan, Citigroup, Wells Fargo and Bank of America is roughly unchanged, except for some differences here and there. On the one hand, revenues from trading activities have decreased again, especially for fixed-income activities. On other hand, there is high growth in consumer segments, such as credit cards and mortgages, which boosted quarterly profits. But interest income (e.g. net-interest margins) remains the most important aspect for future earnings, especially now that the Fed has hinted at interest-rate cuts. The banks indicated that this will have a negative impact on revenues in the coming quarters. Finally, an increase in dividends and buybacks was announced after the banks passed the Fed's stress test at the end of June.

Within our investment strategy, we are taking a more defensive approach. We decided to reduce our position in stocks (from neutral to underweight versus the benchmark). This decision is based on a number of issues that are expected to have an impact over the next couple of months. In general, we think that the risk of a downturn outweighs the potential for further improvement. Of course, central banks reducing rates and adopting a more accommodative policy is clearly positive for investors. But, we think the market has already priced-in the effect of these rate cuts. We also see weaker business sentiment and deteriorating macro-economic data, which is influenced by the continuing uncertainty surrounding the trade dispute between the US and China. This will impact company earnings. In the last couple of weeks, there have been a number of earnings revisions, which indicates a serious likelihood of earnings disappointment. In this environment of slower economic growth, we also adjusted our sector allocation. We are now more positive on the health care sector (moving from neutral to overweight) while the industrials sector is viewed more negatively (moving from neutral to underweight).

Bonds: No surprises expected from the Fed

This week, ten-year US Treasuries consolidated around 2.05%. Last week they had corrected towards 2.13% (11 July) after touching a low of 1.95% (3 July). These movements suggest that the market had priced-in too much Federal Reserve rate-cut action, from which it then corrected.

The Fed is unlikely to surprise markets at its 31 July meeting. Fed policymakers, however, have signalled that they disagree with the market’s rate projections. Also Fed Chair Jerome Powell has hinted that we will see more of an ‘insurance’ cut (so one or two cuts), instead of a series of cuts. ABN AMRO expects a 25-basis-point (bp) cut in July, followed by two further 25 bp cuts by the first quarter of next year.

A review of past easing cycles suggests that the Fed may move more slowly than the market expects. The direction of US Treasury and global government bond yields still depends on factors related to macroeconomics, the US/China trade dispute and the stance of central banks (including in emerging markets.) The central bank of South Korea surprised markets with a rate cut, while progress toward a US/China trade deal has stalled. Additional tariffs could be the next step taken by the US, but China has warned the US to hold back. Additional tariffs would likely lead to trade uncertainties and could imply weaker global economic data going forward. As a result, investments and spending would likely be cut back. In such a situation, financial markets could price-in more rate cut expectations.

Markets have been enthused by European Central Bank President Mario Draghi's signals of further support. As a result, investors have shifted into riskier bonds. There is a hunt for yield at government debt auctions. Greece easily sold EUR 2.5 billion of seven-year notes. The election of a new government in Greece has supported demand for Greece debt. The spread of Greek government debt over ten-year Bunds reached 238 basis points. Italian spreads declined (to 186 bps), as some investors became less concerned about the government's plans to run large budget deficits in order to spur activity as the economy slows. Italy has scaled back budget plans and the government is now more in line with EU budget requirements. Global government bond yields reached and tested multi-year lows. This is not likely to change as Europe heads into summer.