Trade and Brexit optimism sparks rally in equities

Adding to sentiment in equities is what seems to be a breakthrough in the Brexit negotiations. The EU and UK negotiators are both describing the meetings as constructive and the speculation is that UK PM Boris Johnson maybe gave some concessions to Irish PM Varadkar on the Northern Ireland border issue. The reaction is primarily concentrated in the FTSE 250 Index, which comprises of domestically oriented companies, up 2% today whereas FTSE 100 is almost flat for the day except for a few gainers among the banks. Our view is that if a Brexit deal can be made foreign interest in the FTSE 100 will rise as the valuation is attractive with an attractive 5% dividend yield. Tactically UK stocks could become one of the best equity markets next year if we avoid an ugly global recession and UK can kickstart growth again.

The Q3 earnings season is also starting next week although a few companies of less importance have reported this week. Earnings growth has been slowing for the past two years in line with the slowdown in OECD’s global leading indicators. Emerging market companies were holding up longer than companies in the developed world but during 2019 the conditions for emerging markets have deteriorated significantly. EBITDA growth among emerging market companies slipped into negative in June this year while developed market companies are still seeing growth. As we have said repeatedly in the past couple of weeks, we expect earnings growth to go negative and outlook to disappoint as the Q3 earnings season unfolds.

As the table below shows all sectors except health care have seen its profit growth declining significantly from a year ago. The headwinds have been the biggest for financials, energy and materials sectors which is not a surprise given their cyclical nature.

Among the 2,000 companies we track during the earnings season around 84 of them will report next week. The 30 largest companies reporting next week are mostly US companies (see table) with the most interesting from a market impact being:

§  Kweichow Moutai – reports Q3 earnings on Tuesday. Being China’s largest beverage companies it’s a good indicator on consumer spending in China.

§  JPMorgan Chase – reports Q3 earnings on Tuesday. The largest US bank with a big international footprint. Will give insight into how falling rates are impacting banks profitability.

§  Citigroup – reports Q3 earnings on Tuesday. Compared to JPMorgan Chase, Citigroup has a larger footprint in emerging market countries and thus typically gives good insight into sentiment in these economies.

§  ASML – reports Q3 earnings on Wednesday. The first European semiconductor company to report earnings with analysts expecting revenue growth to climb back into positive territory (+8.4%) following two negative quarters.

§  Netflix – reports Q3 earnings on Wednesday. The online TV streaming service has gone from growth darling to worries over competition, pricing pressure, too much debt and profitability concerns. Very important earnings release for longer term sentiment.

§  Honeywell – reports Q3 earnings on Thursday. One the largest industrial companies in the US and thus provide insight into industrial demand and investments in the economy.

§  American Express – reports Q3 earnings on Friday. Good indicator on consumer credit and thus spending. Still a cost efficiency play as the company depends on a mature US market with contained growth rates.