The Daily Prophet: Just Remember Earnings Are Backward-Looking

Connecting the dots in global markets.

One day after they cheered the early results from third-quarter corporate earnings, equity investors had a change of heart. They pushed the S&P 500 Index down the most in seven weeks, as weaker-than-forecast results at companies from Chipotle Mexican Grill to Advanced Micro Devices sent a chill across trading desks.

That’s perfectly fine, except earnings only provide an indication of what has happened, not what will happen. In all honesty, this was not expected to be a strong quarter anyway, with consensus forecasts of profit growth coming in at half the 10 percent or so seen in the first two quarters of 2017. Stock investors are, by nature, an optimistic bunch, and anything in the neighborhood of 5 percent growth should calm nerves and confirm that the economy is performing on trend, according to the equity strategists at Wells Fargo Investment Institute. A modest growth, modest inflation environment is likely to be around for the next year or two, providing support for equities, they pointed out in a research note Wednesday. 

“Do not get caught up in the earnings season hype,” Scott Wren, the senior global equity strategist at Wells Fargo Investment Institute, advised. “A big earnings surprise for the overall market is not in the cards this quarter, in our opinion. Focus on what the economy will do in the future because earnings are a lagging, not leading, indicator.”  

Fixed-income investors, already on edge about the forecasts that bonds are doomed as central banks pull back from the market, won’t take any comfort from the Institute of International Finance’s latest report on global debt. In a study dated Oct. 24, the group said global debt hit a new high of $226 trillion at the end of the second quarter. To put that number in perspective, the total market capitalization of all the world’s stock markets is a relatively puny $89.2 trillion, according to data compiled by Bloomberg. The IIF’s figure consists of government, financial sector, non-financial corporate and household debt. Debt amounts to 324 percent of global gross domestic product, which the IIF frames as good news because that’s down from about 325 percent a year earlier. Also, it says growth in debt outstanding has slowed, to 3.5 percent in the 12 months ended June 30 from 4.2 percent in the prior 12-month period. Although some of the slowdown can be attributed to deleveraging efforts in China’s corporate sector, that nation’s household debt has risen to 104 percent of disposable income, higher than in the U.S. The other big takeaway is that the number of "stressed” firms that can’t cover their interest expense has reached 15 percent to 25 percent of corporate assets in Brazil, India, Turkey and China.

Say what you will about the U.K.’s decision to leave the European Union, at least foreign-exchange traders see better days ahead. Sterling at one points was the biggest gainer against the dollar Wednesday, as the Bloomberg British Pound Index soared the most in more than five weeks after the government said the economy expanded 0.4 percent last quarter. That's not much, but it was unexpected as well as the fastest pace this year. A separate Bloomberg index measuring the pound’s strength relative to its major peers has now risen 3.48 percent over the past three months, making it the best-performing major currency. Traders even increased bets that the Bank of England will raise interest rates when policy makers meet on Nov. 2. “It’s hardly a boom,” Alan Clarke, an economist at Scotiabank in London, told Bloomberg News. “Nonetheless, it removes the last potential hurdle standing in the way of a rate hike at next week’s meeting.” While the International Monetary Fund raised its forecasts this month for almost every advanced economy, the U.K. outlook was left unchanged, according to Bloomberg News’s David Goodman and Jill Ward. At 1.7 percent this year and 1.5 percent in 2018, it will grow at half the global average.

At the other end of the currency spectrum is the South African rand. The currency was the world’s worst performer Wednesday, tumbling the most since March and weighing on emerging markets in general after the government forecast higher debt and wider fiscal deficits over the next three years. The outlook basically means investors should brace for further credit ratings downgrades as a fight for control of the ruling party limits policy choices, according to Bloomberg News’s Mike Cohen and Arabile Gumede. Specifically, the deteriorating debt trajectory could trigger a cut in the country’s local-currency debt rating to junk by S&P Global Ratings and Moody’s Investors Service, which could spur capital outflows. At the least, the weakness in the rand highlights a reversal in the fortunes of emerging markets in recent weeks. After a big run-up this year through early September, gaining 10 percent, the MSCI EM Currency Index has slid 2.10 percent amid some fresh political turbulence not only in South Africa, but Brazil, Turkey and Mexico as well -- all bellwethers for emerging markets.

The star of the day in commodities goes to aluminum, which jumped even though raw materials broadly slumped. Used in everything from planes to drinking cans, aluminum’s 1.4 percent rally to $2,186 a ton brought its gains for the year to an impressive 29.1 percent. In contrast, the Bloomberg Commodities Index has slumped 1.86 percent. Aluminum got a vote of confidence Wednesday from the Bank of China, one of the country’s top four commercial banks, which said the metal will probably climb on the nation’s capacity cuts and output curbs during the winter to cut pollution, Bloomberg News reported. The firm sees aluminum rising to $2,300 a ton in the first three months of 2018. Separately, Aluminum Corp. of China, the country’s largest state-owned producer, called for curbs on futures speculation after prices in Shanghai climbed to the highest in six years and trading jumped to a record. “Aluminum is for production, not speculation, and all of society should curb speculation that distorts the market,” Chairman Ge Honglin said by email in response to questions from Bloomberg News. China produces more than half of the world’s aluminum.

The big event of the week occurs Thursday, when the European Central Bank unveils its plan to scale back purchases of bonds under its quantitative easing program. The consensus is that monthly bond purchases will be cut in half to 30 billion euros ($35 billion) for most of next year. So any amount that differs from that number is likely to roil markets. Investors will also be listening for President Mario Draghi’s comments on the future path of interest rates. According to the economists at Bloomberg Intelligence, none of the 25 members of the ECB’s Governing Council has called for a rate hike, suggesting that the central bank is likely to reiterate that rates will “remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.” The longer the QE horizon the stronger the guidance will be, but a rate hike is unlikely before mid-2019 regardless of whether QE is extended for six or nine months, according to the BI economists.

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