Market Comment - Equity Roundtable: An early look at the earnings season

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The fourth-quarter earnings season is underway – close to 60% of US companies and about 30% of European companies have reported so far. The results can best be described as mixed. This Roundtable discussion with ABN AMRO Equity experts, Piet Schimmel (PS), Joost Olde Riekerink (JOR), Arthur Boelman (AB) and Jan Wirken (JW), gives an early look at what companies are saying and what it means for investors.

What’s so important about this earnings season?

PS: Some earnings seasons are more interesting than others. This one is important because companies are providing their first guidance for 2019. It gives us a chance to see what their assumptions are for the year.

JOR: You also see that a number of companies are struggling with their guidance. They need to figure out how to deal with various negative factors and uncertainty.

AB: For me, the main takeaway is how mixed the overall picture is so far and how companies are differently affected by the trade war and the slowdown in China. We see the effects varying significantly among companies even in the same sector.

What has surprised you?

JOR: Some companies that missed earnings still saw that their results triggering rebounds. While for others, positive surprises triggered sell-offs.

AB: Apple and GE are two examples. They had both been hurt by sell-offs in the last quarter of 2018, so expectations for their earnings results were fairly low. Everyone was afraid that their results would be very poor. What we saw was that when their results were not as bad as feared, there were relief rallies.

PS: I was surprised by the strong user growth reported by some social media companies, such as Facebook and YouTube. Given the data privacy issues that surfaced over the past year, it could have been expected that user growth would stabilise or decline. But the opposite was true. Some platforms saw increases of 10-20% in user growth.

JW: What surprised me is that within the industrials sector, the power (turbines) segment is still very weak. In the energy sector, we also see capital expenditures (capex) rising in US shale oil companies. Most companies see the China slowdown as a headwind for 2019.

What seems to be the most common topics that companies are talking about?

PS: There are a few issues that are mentioned by almost every company: the trade dispute between the US and China and the economic slowdown in Europe and China might be the most important.

AB: The trade war is raising input prices and pressuring company margins across a range of sectors. So margin pressure is a common topic as well.

JOR: What’s also putting pressure on margins is technology costs, as companies introduce new technology and make capital expenditures to improve productivity. It puts short-term pressure on both profits and margins, but is needed for future growth.

PS: And technology companies themselves, like Alphabet, are complaining about margin pressures related to labour costs. Both low-skilled and highly-skilled labour is becoming more expensive for them.

AB: Another common theme among companies is sustainability. Companies are recognising how important sustainability is becoming to both institutional and private investors. Nearly every company seems to have incorporated something about sustainability in their investor reporting.

ABN AMRO currently has a neutral allocation to stocks and for most sectors, except energy, which is the one sector that is favoured. Despite this neutral view, do you see other areas of opportunity?

JW: The energy sector is preferred based on our expectation for oil prices to rise in 2019. And despite the 2018 decline in oil prices, energy companies are increasing their capital expenditures as a way to ensure future growth. Rising oil prices are also a factor in our preference for the commodities sector as a whole.

PS: Follow the capex! In addition to energy, there are increasing capex investments in technology across a range of sectors. This should benefit the large cloud computing platforms, software and IT services companies.

JOR: It really is a story of ‘follow the investments.’ Digitalisation is an ongoing goal for many corporates. We see that most companies enabling digitalisation are still experiencing good cash flows.

AB: Quality stocks may also be of interest, given that they typically perform better than the broader market when markets decline. With characteristics that include low leverage and a solid return on equity, they have a resilience that can be beneficial when times are tough.

What’s your advice to investors?

PS: So far, the earnings season, for me, confirms our neutral stance toward stocks and most sectors. We are not negative – we do not expect a recession -- but we did advise reducing equity risk in portfolios last month.

JOR: I agree. And even though it looks calm at the moment be aware of increasing market volatility. When the picture becomes more clear, then it’s time to follow the capex investments.

AB: A neutral allocation also gives flexibility. It is still early days for this earnings season and this investment year. With more clarity will come more conviction.

JW: My advice is to be prepared take some risk off the table. Since the December low, the Euro Stoxx 50 Index has risen by 10%. There may therefore be some market pull-back ahead.

Piet Schimmel is Senior Equity Thematic Expert; Joost Olde Riekerink is Equity Research & Advisory Expert, Arthur Boelman is Equity Research & Advisory Expert covering the utilities and consumer staples sectors. Jan Wirken is an Equity Expert following the industrials, materials, energy and consumer discretionary sectors.