Wall Street needs strong earnings to sustain global stocks lead

LONDON Fri Apr 12, 2013 8:39am EDT

Commuters are reflected in stone as they walk past the JP Morgan headquarters in New York in this file photo taken May 17, 2012. JPMorgan Chase & Co posted an increase in first-quarter profits on Friday as the biggest U.S. bank benefited from lower expenses. REUTERS/Eduardo Munoz/Files

Commuters are reflected in stone as they walk past the JP Morgan headquarters in New York in this file photo taken May 17, 2012. JPMorgan Chase & Co posted an increase in first-quarter profits on Friday as the biggest U.S. bank benefited from lower expenses.

Credit: Reuters/Eduardo Munoz/Files

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LONDON (Reuters) - First-quarter U.S. corporate earnings must show strong evidence that a secular improvement in the economy is benefiting American business if Wall Street is to sustain its leadership of a global stocks rally.

As debt grinds down the euro zone and fears of slowing growth and diminishing yield advantage haunt emerging markets, the world's biggest economy is not only riding a stocks rally but also reclaiming some manufacturing business from China, whose stocks are among the worst performers so far this year.

Early favorable results from Alcoa and JP Morgan have set the moderately positive tone for the start of the U.S. earnings season.

The risk of a repeat of 2012's mid-year stocks sell-off nags at investors, but strong factory and housing data and anecdotes of U.S. companies "reshoring" their factory base back home support a picture of revitalization.

"We've been in this environment where the U.S. has persistently surprised on the upside. The financial transmission mechanism is looking a lot better than just about anywhere else," said Philip Saunders, head of the global asset allocation team at Investec Asset Management.

"It's natural for market participants to be concerned about faltering underlying macro data. We need some earnings confirmation in order to support this particular advance."

As the main U.S. equity indexes such as Dow and S&P 500 print new highs almost on a daily basis, investors are reasonably beginning to worry the rally at a global level may lose steam soon.

In 2012, the global equity market, measured by MSCI enjoyed strong gains in the first three months, only to lose more than 10 percent towards the mid-year.

London-based hedge fund SLJ Macro Partners, using a sample of six developed markets and data from the past 32 years, found the May-October period has average equity losses of 1.8 percent, compared with the November-April return of 14.3 percent.

This month's disappointing jobs data raised concerns that the economy may be entering a soft patch, like last year's.

Expectations for earnings are not too rosy, at least for this reporting quarter. Data from Thomson Reuters shows earnings growth at S&P 500 firms is likely to be just 1.2 percent in the first quarter, down from 6.3 percent in the final three months of 2012.

Strong earnings growth is unlikely to come until later in the year, with earnings per share (EPS) seen expanding at a rate of 6 percent in the second quarter and at more than 10 percent in the second half of 2013.

"The expectations on the earnings are already so low that we may end up seeing the equity markets reasonably supported if the earnings don't miss the forecasts by a large margin," said Stephen Jen, managing partner at SLJ.

Demand for downside protection also highlights growing investor caution on Wall Street. JP Morgan says exchange-trade funds that track the Volatility Index, Wall Street's fear gauge, have attracted net inflows of $2 billion this year.

"RESHORING" REVIVAL

Even if there is a possibility of some short-term disappointment in earnings, Wall Street can look to the resurgence in U.S. manufacturing.

Multinational companies such as GE and Caterpillar are moving some of their factories back to the United States at a time when labor costs in China are soaring.

Boston Consulting Group's survey last year found more than a third of large manufacturers, with annual sales of over $1 billion, are planning to bring back production to the United States from no longer cheap China.

BCG expects that by around 2015, average manufacturing costs in China will be just 7 percent lower than those of the United States, less than half the level a decade ago. These costs do not include transportation, duties, and other expenses.

It's perhaps too early for equities to fully reflect this secular shift, but the dollar-based MSCI China index is down nearly 6 percent so far this year.

"The U.S. economy is indeed starting to show signs of a cyclical soft spot. From a secular basis, however, there are great positives on the United States, and therefore the view on the dollar and U.S. equities," Jen said.

(Editing by Ruth Pitchford)

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