16 April 2019 – Strong start to earnings season but profit recession is in prospect; the oil price rallies on supply fears; and tech flotations are in focus as short-sellers move in on Lyft.
The sugar rush of last year’s tax reforms is well and truly over with analysts now predicting two consecutive quarters of falling corporate earnings. If correct, this would be the first earnings recession since the financial crisis, raising fears about a more general downturn for the US economy after a decade of expansion.
Consensus forecasts collated by data group Factset now point to a 0.4% drop in earnings for the three months to June. That modest decline would follow an estimated 4.6% fall in the first quarter and follows a strong year for US profits, including three quarters in which earnings grew by more than 20% year on year.
That strong growth was largely a consequence of Donald Trump’s tax reforms, which provided a one-off boost to company profits but which by definition was unsustainable. Corporate profits are now coming under pressure as the global economic outlook worsens. This week the International Monetary Fund reduced its forecasts for global growth in both 2019 and 2020.
The IMF said it now expects the global economy to grow by 3.3% in 2019, down from its previous forecast made in October of 3.7%. The projected growth rate for 2020 is 3.6%, down 0.1 percentage points. Both of these falls are despite still strong growth in China and India, where growth rates in excess of 6% are expected to hold up this year.
What is unclear now is whether late-cycle slowing in activity leads inevitably to a recession or whether supportive central banks can effect a soft landing. Recent signals from the bond market, including a so-called inversion of the yield curve, have raised alarm bells about the growing likelihood of a full-blown recession.
One of the key drivers of the growth slowdown has been rising trade tensions between China and the US. Although, there are promising signs of a resolution of these, a deal remains in the future. Hopes for a summit between Presidents Xi and Trump have been pushed back as talks have dragged on with continuing differences between the two sides.
Ongoing worries about trade lay behind the biggest tumble in weeks for the Chinese stock market last week. Thursday saw a drop of more than 2% for the CSI 300 index that tracks stocks in Shanghai and Shenzhen.
Shares have pulled back after a very strong first quarter, with foreign investors in particular stepping back from putting money to work in China. Daily inflows via the two exchanges links with Hong Kong have slowed as investors have seemingly looked to lock in recent gains.
Chinese stocks may have paused for breath but the oil price continues to register new highs as the cost of Brent crude rose to $72 a barrel. This means the rise in the oil price since December has now reached 35%, although crude remains well below its $86 recent high, reached in October.
The rally so far this year may have further to go if forecasts from Opec and the International Energy Agency, pointing to an ongoing supply shortfall, turn out to be correct. Saudi Arabia has reined in production and there has been a drop in output from Venezuela and Iran, which are subject to US sanctions.
The oil market is self-regulating to a degree. Higher prices encourage more production, with the US Shale fields now the main swing factor in a global market that is less dependent on Opec’s mainly middle-eastern suppliers than it was.
New pipelines opening up in the second half of the year should make it easier for oil to reach the market, adding downward pressure on the price.
The other key factor is the willingness of big producers like Saudi Arabia to comply with pressure from President Trump to increase production and so keep a lid on the price. With an election coming up in around 18 months, the President is keen to keep the cost of petrol low in America. Although a higher price helps the US’s sizeable oil industry, cheap gas is a vote-winner among the much bigger constituency of US motorists.
This week should provide some further insights into the health of the US economy with retail sales, industrial production and trade data due to be announced. In a busy pre-Easter week, there will also be wage growth and inflation numbers in the UK and Chinese GDP figures for the first quarter.
With stock markets riding high, despite more recent worries about the sustainability of growth, it is no surprise that flotations are back in focus. The technology sector, in particular, has attracted plenty of investor interest with the latest company testing the market’s appetite being online taxi service Uber. It is expected to raise around $10bn of new money in a float that could value the company at $100bn. That would be one of the largest ever US IPOs, although a bit less than expected.
Sentiment towards tech flotations has been dented in the past few weeks by the IPO of Uber’s rival Lyft, which has seen its shares fall back below the flotation price of $72 despite an initial pop above the launch price.
Another tech stock looking to come to the market is Pinterest, the scrapbooking website which is thought to be looking to price at between $15 and $17 a share. Again this is below recent expectations. The company was valued at more than $21 a share by a recent private fundraising round.
One of the challenges facing fast-growing but as yet unprofitable tech companies is persuading investors that the jam tomorrow will be worth the up-front cost today. Uber’s IPO prospectus, which was released this week showed a company that is still burning through cash in a bid to maintain share in a competitive market place.
And finally, just in case you thought Brexit had been put to bed for the next six months, think again. As well as the looming local and European elections, Brexit remains top of the agenda for investors here in the UK, with the chaos of our departure from the EU blamed for a fourth consecutive week of outflows from UK-focused funds.
Investors withdrew over $300m from funds invested in UK shares extending the total since the referendum three years ago to $25bn. Despite the outflows, the FTSE 100 index has gained around 10% so far this year, bouncing back from the loss-making fourth quarter of 2018 as investors focused on the cheap valuations compared with both history and other stock markets and alternative investment assets. It remains to be seen whether prices or flows are telling the truth.