Opinion

The US equity market has rebounded some 15 percent from its low in June, helped by hopes of a Fed turnaround, better-than-expected corporate results and investors who were gloomy but invested.

The June low remarkably coincided with the peak in earnings expectations for 2022 and 2023. This means the entire price recovery can be attributed to higher valuations, made possible by lower interest rates. The fact that corporate earnings were better than expected, however, says more about expectations than about the underlying earnings trend.

Valuation is often not the immediate trigger for a stock market turnaround. But it is a decisive factor in the amount of upward or downward potential for the market.

Re-rating

Since its low point in mid-June, the S&P 500 Index has risen 18 per cent. Over the same period, earnings per share rose by less than 2 per cent. There has thus been a considerable re-rating of equities over the past two months.

European gas and electricity prices break records almost daily. The effect of energy on an economy is often underestimated. Almost all economic activity consists of energy, but in a different form. 

The value of a currency is based on trust. The Russian sanctions have not helped the status of Western currencies. Yet crypto currencies also have difficulty escaping Western sanctions. The digital currency issued by China’s central bank, also known as the e-yuan, is succeeding. It may gradually gain market share from the dollar.

The US macro data show a mixed picture. GDP – before revisions at least –  has contracted for two quarters in a row. For Europeans, that is a recession.

The ISM Manufacturing index fell further, but is still above 50. ISM Services unexpectedly rose to 56.7. More than half a million jobs were added in July. And yet it has felt like a recession for a while.

Forty years ago this week the bull market started in the United States. Not just any bull market, but the biggest bull market ever. Despite the crash of 1987, the dotcom graveyard, the attacks of 11 September 2001, the Great Financial Crisis and the Covid pandemic, this bull market continued to rise, fuelled by structurally falling interest rates, higher valuations and sharply rising profits.

The Dow Jones bottomed forty years ago on 12 August 1982 at 777 points, the same level as in January 1964. 

Retail giant Walmart issued another profit warning last week. And the underlying reasons point to a stagnant US economy.

Walmart pointed to a change in the spending pattern of American consumers. As a result of the continuing rise in food prices, Americans have no money left for other purchases. In order to get rid of the increasing stock, Walmart has to lower its prices considerably, which results in lower profits.

And then things moved fast. Business confidence fell to worrying levels in July, making a recession, especially in Europe, seem inevitable.

The S&P Global Flash Composite (Manufacturing + Services) PMI for Germany fell to 48.0. Well below the “magic” level of 50, seen by many as the line between economic growth and contraction - even though the actual level of negative GDP growth is considerably lower. The Manufacturing PMI also fell to 49.2.

Time and again I look for it. And every time I do not find it. What is it about? I look for the word “money growth” in interviews and speeches by board members of the European Central Bank. That is strange and revealing at the same time. 

The earnings season has only just begun, but we are already seeing some examples of what will become a trend: fewer companies beating expectations.

Investors like to be positively surprised, so companies tend to be overly cautious in their expectations so as not to disappoint those same investors. But when the economy is heading for recession, expectations are met less often and this earnings season is probably the first indication of this.