Earnings season didn't disappoint this quarter, exactly. Indeed, global earnings and the Canadian economy in particular have both surprised analysts this year. Still, 2019 is going to go down as a pretty weak year for global earnings.
However, we are seeing a fair bit of support for earnings, both for the remainder of this year and beyond. Interest rates are lower, wage growth inflation hasn't materialized as much as expected, money supply is expanding and jobless claims and credit spreads all remain supportive to economies and stock markets alike. Most notably, slightly higher Purchasing Managers' Index (PMI) readings suggest that earnings could move into more stable territory in 2020.
The Purchasing Managers' Index measures the state of the economy... and things are looking up
This survey of supply chain managers across different industries provides information about the direction of economic trends in the manufacturing and service sectors so that decision makers have information about current and future business conditions. In other words, it can tell us if economic conditions are expanding, staying the same or contracting.
Currently, global PMI readings have indicated that growth is slowing, but have been trending upwards since the middle of the year. Going forward, we expect PMI measures to move into expansionary territory and to continue to increase on a month-over-month basis, providing support to the global economy.
Should the global economy continue to provide growth—even sluggish growth—we should see corporate earnings continue to improve.
More of the same for 2019 and a look ahead to 2020
Year-over-year earnings growth estimates remain weak across the board and well below historical averages in the current business cycle. Around the world, analysts are calling for 2.1% growth in the U.S., 1.5% for the Eurozone, 0.7% in the U.K. and 6.5% in Japan for 2019.
Consensus estimates put earnings per share growth at approximately 10% in 2020, but we believe these estimates, at the moment, are probably a little over-optimistic. Given that earnings are directly tied to the global economy, performance over the next 6 to 12 months largely depends on the global economy's ability to expand.
Continued strength also relies heavily on the easing of geopolitical tensions in the U.K. (Brexit) and between the U.S. and China (trade). If we do see improvements here, this too could act as a catalyst and spur a modest upturn in global earnings.
Additionally, global monetary policy efforts already underway should also provide positive economic stimulus as lower rates come fully into effect in 2020.
Not surprisingly, there is disparity in earnings growth around the world
In the U.S., analysts are calling for a modest upturn in earnings growth over the next 12 months. Return on equity (ROE), the measure of how efficiently a company uses equity to generate earnings growth, is well above the mean for consumer and technology stocks, while sectors like energy, materials and real estate still have room to expand margins, take on debt or prop up the amounts companies are returning to shareholders.
Similarly, in Canada where earnings are at all time highs, positive earnings growth is being driven by financials and the resource sector, both of which are displaying below average ROE.
In Japan, on the other hand, earnings have risen dramatically and it's quite possible that shareholders are already enjoying the maximum ROE that companies are able to deliver. Japanese companies have been under pressure to become more shareholder friendly and thus have improved their efficiency in a number of areas.
Conversely, earnings in the U.K. collapsed in 2016 and have been trying to recover ever since. Earnings have a lot of room to grow, but have stagnated due to Brexit-related concerns and constraints.
The Eurozone is an interesting place to watch for changing trends in the business cycle. Brexit is having an effect on earnings and there is considerable political instability in Italy. Although Germany has been a source of strength for the Eurozone since the financial crisis, it too is now facing a very specific and targeted manufacturing slowdown.
Growth in China continues to slow as the country gets away from the big investment, debt-laden buildup of growth it had been pursuing prior to 2016. Their relatively new focus on growing domestic demand to become less dependent on the global economy, has provided some support which should offset some of the slowdown being caused by the ongoing trade spat with the U.S.
Our strategy reflects our more cautious stance
We are calling for higher earnings going forward, but we don't expect a booming pickup or a return to 2017 and 2018 when U.S. corporate tax cuts (which inflated last year's corporate earnings beyond historical averages) drove earnings per share growth well over 20% and markets enjoyed a synchronized rebound.
Although our view is that U.S. economic expansion is not yet over—we believe there is a lower probability of recession today than there was a few months ago—we are less optimistic about stocks and consequently have recently reduced our allocation. We are not expecting an outright contraction, but we are less bullish about the opportunity at this time, and therefore have taken a smaller position.
In bonds, we have actively reduced our portfolio's sensitivity to interest rate changes as we expect the yield curve to steepen (the spread between long- and short-term bond rates to widen). We believe that bond yields will most likely move higher with the economy, which may put pressure on bond prices going forward.
For more information about this or our recent portfolio adjustments, please contact your MD Advisor*.
Data source: Institutional Brokers’ Estimate System (I/B/E/S)
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).