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Will corporate earnings unlock investment returns in 2020?

Graham Smith

Graham Smith - Market Commentator

The latest soundings from Tehran, Washington and Beijing may have driven market sentiment so far this year, but the focus is about to turn to corporate bottom lines. As companies start to report their earnings for the final quarter of 2019, the prospects for 2020 will come into sharper focus.

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This is especially important for the US, where stock markets ratcheted up more record highs this week on hopes of a new trade deal with China1.

These formative days of 2020 mirror markets last year, which advanced partly on hopes a turnaround at America’s central bank – from a path of raising interest rates to a course of cutting them – would eventually boost economic growth and corporate earnings.

So this corporate earnings season has the capacity to bring sentiment back down to earth or give it a fresh boost. It will be a measure of how the gamut of issues affecting corporate profits have added up, amid the fading effects of large tax cuts in America in 2018.

More importantly, it will provide the 2020 outlook statements from companies that will help shape expectations for earnings over the year ahead.

Latest estimates point to a 0.6% decline in US corporate earnings in the final three months of 2019 as compared with the same quarter a year earlier2.

This, in itself, is not a cause for great concern for two reasons. First, estimates have a habit of undershooting the true picture. The final result for the quarter could end up being modestly positive.

Second, even a year of falling or flat earnings is no guaranteed precursor to a poor year for equity returns. In 2015 and 2016 earnings for America’s S&P 500 Index fell or were only just in the blue, but shares went up the following year3.

This quarter the results from retailers will be of particular interest, since it was largely robust consumer spending that kept the US economy heading in the right direction last year. Even as headwinds like rising raw materials prices and slowing global growth buffeted the US economy, retail sales growth held up4.

Incidentally, the same will be true in the UK. Christmas trading statements have thus far revealed no let up in the pressure being heaped on Britain’s big grocers at the hands of the discounters. Signs of the end of the long-drawn-out demise of Beales this week paint a similar picture for department stores.

Perhaps where expectations will most notably meet reality is in America’s technology sector. Tech stocks have led the charge on Wall Street over the past year, with Google owner Alphabet recently becoming the fourth listed company in America to see its market value rise to around US$1 trillion5. Share price rises last year dwarfed earnings gains so, for them, the 2020 outlook will be especially important.

Oil and gas companies are likely to report continuing pressures on earnings as a result of increasing production in America’s shale fields keeping the lid on oil prices. However, recent positive signs that China’s economy has stabilised and the lagged effects of interest rate cuts in the US make an increase in the demand for oil likely this year.

First out of the blocks this week were America’s big banks with encouragingly strong earnings reports from JP Morgan and Citigroup6. So, a good start, all the more so because falling interest rates last year – the Fed cut three times – will have made these banks less profitable. More evidence, it would seem, of a US economy outperforming reduced expectations.

For investors seeking a more balanced approach this year after a highly successful year for markets in 2019, a greater degree of diversification could be a sensible course to take. The Fidelity Select 50 Balanced Fund offers one route to this.

This fund is interesting in that it mainly chooses its investments from Fidelity’s Select 50 list of favourite funds. It is highly diversified across world equity and bond markets, with around 250 holdings in equities and 630 holdings in bonds through its fund investments. This enables it to participate in the long term growth in stock markets while ensuring risks are tightly managed.

Source:

Bloomberg, 15.01.20
I/B/E/S data from Refinitiv
FactSet, 21.12.18
United States Census Bureau, 13.12.19
5CNBC, 13.01.20
Wall Street Journal, 14.01.20

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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