Despite concerns of a US and global slowdown, results from earnings season were better than expected. In this article, Cormac Weldon highlights his findings and the impact on positioning...
The second quarter’s ‘earnings season’ is now over. Showing an increase of 1% year-on-year, growth in earnings was better than expected.
Main themes from reported earnings:
- Further action has been taken by companies to reduce the impact of the tensions between the US and China on trade. Production has either been shifted away from China; or plans were announced to raise prices, thus offsetting increased tariffs.
- Some investment decisions have also been delayed.
- Continued pressure on corporate margins as a result of the tight labour market, higher commodity costs and a stronger USD.
- Concerns about US and global economic growth - but no actual recession.
- Lower borrowing costs resulted in higher corporate leverage.
In the wider economy, August saw a sharp drop in CEOs’ confidence (down by 6% on the previous month). That’s almost 20% lower than its peak in 2018 – and confidence drives both capital expenditure (capex) and jobs.
A clear slowdown in manufacturing employment shows that declining business confidence risks weakening job gains and, in turn, consumer spending.
What is our thinking?
The economic cycle is now beyond its peak - as confirmed by the latest Institute for Supply Management’s reading coming in below 50. The Institute’s latest report saw: “New orders, production and employment contracting; supplier deliveries slowing at a slower rate; backlog contracting … Exports and imports contracting.”
US business confidence drives both capex and jobs. August has seen a sharp drop in CEOs’ confidence (down by 6% month-on-month). That’s almost 20% lower than its peak in 2018; and a fall in business confidence suggests downside risk for the job market.
Meanwhile, the clear slowdown in manufacturing employment (also highlighted by the ISM/Markit PMIs) is showing that declining business confidence risks weakening job gains and, in turn, consumer spending.
So we are now watching for any sign of weakening in employment data; and are looking closely at the weekly jobless claims. A further concern is that a drop in business confidence might also lead to cuts in spending on capex.
What does this mean for stock selection?
Overall valuations are stretched. That makes it hard to justify buying cyclical companies at this stage. Two exceptions at sectoral level, in our view, are housing and semi-conductors. The first will benefit from lower interest rates. The second has a cycle of its own.
We are comfortable with our more defensive positioning: examples are Booz Allen Hamilton (government services contractor) and Crown Castle (wireless cell towers).
Tariffs/China are still dominating the newsflow and could lead to an increase in volatility. Our view is that the trade conflict is unlikely to get resolved in the short term or before the election. For us, overall exposure to China is relatively low: we took that down in the second half of last year.
Within housing, we continue to like Masco. It sells paint and plumbing equipment - more aimed at the repair and remodel than at the new housing market – and continues to do well.
We also benefited from Lowes, a home improvement retailer, that is going through a turnaround under new management. Lowes has traditionally underperformed its larger competitor, Home Depot. Towards the end of last year, it reported a disappointing quarter which caused the market to lose faith in the turnaround. We recently increased our holding and have been rewarded by much better-than-expected earnings in the most recent quarter.
Overall, we continue to have a bias away from companies that benefit from economic growth and towards those whose prospects are less dependent on wider economic conditions.
To find out more about the Artemis US Select Fund and the Artemis US Smaller Companies Fund and their positioning visit the fund pages at www.artemisfunds.com.
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