Reporting season for 2Q corporate earnings begins in the next few days. Investors are very worried and the market’s movements, winners and losers reflect that worry. However, the worries moving the market have little to do with 2Q earnings. Our best guess is that 2Q earnings reports will be better than expected and that investors will turn more optimistic, at least in the short-term.
A short list of investor fears:
- Interest rates will go negative.
- The Federal Reserve has no further tools to manage an economic shock.
- Europe and its banks will unravel; Italy is the current topic of discussion.
- China has major economic risks that are not known.
- Economic weakness and monetary stimulus abroad will drive the dollar higher resulting in headwinds for U.S. multinational companies.
- The upcoming election is a no-win situation for investors – either growth-stifling regulatory and anti-business environment or unpredictable rhetoric and policy.
Despite all of the above concerns, it appears that the U.S. economy continues to improve. Consumer financial health is very strong with Household Debt Service Ratio lower than it has been since 1980. Consumer assets are 7x consumer debt. Labor market slack has returned to 20-year norms. The dollar and energy prices have stabilized, which will ease these recent market headwinds. Earnings estimate revisions are now balanced between upward and downward revisions. All-in-all, we expect that 2Q16 earnings reports will be a pleasant surprise for a nervous market.
While the market was up 4.1% in the first half of the year, the gain was driven by telecom (up 26%) and utilities (up 23.3%); both are fear-driven, defensive sectors that are reaching multi-year highs. While some of the larger fears persist, we expect that good economic news will lead to relative outperformance of less defensive stocks in the second half of the year.
Mary Beth Poggi, CFA ®, is Head of Research at Alpha Omega Wealth Management. Mary Beth has 19 years of experience in financial services, having developed expertise in investment research, investor relations, strategy and individual consulting. For feedback or questions regarding this blog post, please contact Mary Beth at firstname.lastname@example.org.