Global Weekly - Looking for guidance

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Now that the earnings season in full swing, the focus of investors moves to the quarterly results and a bit away from fears regarding rising interest rates.

Unlike previous earnings seasons, quarterly results did not support equity prices so far this year, and equity markets continued their downward trend. The S&P 500 and Dow Jones indices have now erased their gains for the year. European as well as emerging market equities have sunk deeper into negative territory.

In the US, 155 companies out of the S&P 500 have reported their quarterly results this week. The reported numbers show strong earnings growth of more than 23%. Expectations, however, are high and even slight disappointments get punished. The question is to which extent these strong results are sustainable. Or have companies reached peak margins? As a result, investors focus in particular on the guidance.

Especially the industrials and IT sectors were in focus this week. Machinery maker Caterpillar got under pressure, despite reporting in-line results. This was just because Caterpillar did not raise its guidance again as it did before. 3M lowered its earnings guidance, because of cost inflation due to trade tariffs. In the IT space, semiconductors lead the decline after Texas Instruments, STMicroelectronics and AMS announced a more careful outlook.

Nonetheless, we remain constructive for equities and maintain our preference for the US over Europe. In Europe, earnings are under pressure and earnings momentum is trending downwards. As such, despite cheap valuations, we consider the European market less attractive. In the US, business confidence remains high and it even surprised on the upside this week.

Despite negative reactions to the quarterly results so far, the earnings season is still young. Especially some IT heavyweights have not reported yet. Facebook, Apple and Exxon Mobil, for example, will report their quarterly results next week, and we expect sentiment to improve again.

Italy and European Commission clash

On Thursday, the European Central Bank (ECB) confirmed its intention to scale down buying bonds towards the end of this year. Even though some growth and confidence indicator numbers disappointed recently.

Interest rates will be maintained at their record lows “at least through the summer of 2019”. Rate hikes will most likely start from there. The ECB still considers risks to economic growth to be “broadly balanced”, leaving their view unchanged compared to their previous meetings. Interestingly, ECB President Mario Draghi noted regarding Italy that the ECB will not intervene as a mediator in case of a crisis.

With its decision regarding Italy, the European Commission (EC) for the first time has rejected a budget plan of one of its members. The Italian government is now supposed to be reconsidering its budget plan. There are no signs yet, however, that the country intends to comply with Brussels.

The only thing the EC can do, if Italy sticks to its budget, is fine Italy for 0.2% of its GDP. This seems to be an unlikely option, as it only adds to Italy’s deficit and will probably only make the Italian populists stronger, which could potentially lead to even more trouble in the future.

The financial markets are therefore potentially a bigger influence on Italy’s budget plans. With increasing debt levels under the current plans, markets could punish Italian bonds further. Possibly even to a point at which the Italian banking system becomes unsustainable. Italy then, is forced to change its budget.

Fortunately for Italy, rating agencies are not putting additional pressure on the country over the next few weeks. Although Moody’s did downgrade Italy to Baa3 recently (just one notch above junk status), Moody’s does not expect to downgrade further on the short term, given its stable outlook. Rating agency S&P will probably follow the same course. Nevertheless, we expect the spread on Italian government bonds to remain volatile in the coming weeks.

Regarding credits, we have seen some disappointing company results. Also, forward guidance is putting some upward pressure on credit spreads. This is adding to a risk-off sentiment on the markets, which is driving bond yields down, away from recent higher levels.