Earnings review

This week we could finally see fundamentals replacing politics as a driver of markets. Price action on Monday suggests that the market is taking the news that Joe Biden is leaving the Presidential race and the likely nominee for the Democrats will be Vice President Harris in its stride. Stocks are higher in Europe and the at the start of this week.

The prospect of a Harris Presidency is risk positive in our view, because Harris is likely to mean more of the same and a continuation of the policies that the Democrats pursued under President Biden. These include the Inflation Reduction act, funding for green technology and access to affordable health care. Under the Biden administration the US economy flourished, and stocks made record highs. Thus, the prospect of a similar political environment under a potential Harris presidency is not worrying markets.

However, VP Harris will not be confirmed as the Democratic candidate until next month. With so much uncertainty around the outcome of the US election, the focus is likely to shift to Q2 earnings season. The peak of earnings season is this week, with more than 200 S&P 500 companies reporting earnings and there are some key releases in the UK and Europe. Below are three factors to watch in the coming week.

How the broader market performs

In recent years, the focus has been on the Magnificent 7, particularly Nvidia’s monster earnings reports, which have dominated the market. While Nvidia’s results are still extremely important for overall sentiment, and we expect another mega report for the last quarter, there is a hope that sales growth and revenues can pick up across a broad range of global markets and sectors. Overall, revenue growth surprised on the upside last quarter. This quarter, analysts are expecting a pickup in revenue growth for materials and healthcare, which may offset a deceleration in revenue growth for the consumer discretionary sector and the broader tech sector.

Earnings season so far

So far, earnings season has got off to a mixed start in the US, according to FactSet. The number of companies reporting earnings above estimates is higher than the long-term average, however, the magnitude of better-than-expected earnings is below average. 80% of US companies that have reported earnings already have reported earnings above estimates, however the earnings beat is 5.5%, which is below the long-term average of 8.6%. There is also mixed results between sectors. For example, financial companies have beaten analyst estimates, while the US’s energy sector has posted weaker earnings than expected for last quarter. The blended revenue growth rate for Q2 is currently 4.7%. However, this is a busy week for earnings and multiple sectors will report results. Thus, although earnings season for the US blue chip index looks solid right now, a lot can change in a week.

Developing themes

As we progress through earnings season, some themes are developing. The first is a sign that service sector inflation could be about to tail off, after Ryanair issued a profit warning and said that it would slash the cost of flights this summer. Ryanair’s share price was down nearly 10% on Monday. This could be a sign that consumer discretionary spending could be about to take a hit as the consumer in Europe and elsewhere turns more cautious. This is to be expected as unemployment rates creep higher in the West, the side effect of this could be more pressure on central banks to cut rates in the coming weeks and months.

The details of the Ryanair earnings report for the previous quarter were brutal. Average fares have fallen by 15%, profit after tax fell by nearly 50%, and was EUR 360mn, down from EUR 663mn. It is worth noting that the decline in fares come from a high base, added to this, Ryanair made hay while the sun shone and people spent freely on travel. However, while the good times could not last forever, the company seems to have been taken aback by the sharpness of the decline. Ryanair execs had previously expected fares last quarter to be flat to modestly higher. Boeing delays and other staff costs, along with a 1% decline in sales for the previous quarter also impacted these results.

Ryanair is the first of the major European airlines to report results, and it does not bode well for IAG, easyJet and Whizz Air, who all report results next week. Hotels and airlines are some of the worst performing stocks at the start of the week on the back of the Ryanair results. Ryanair’s misfortune could also be a warning sign for major retailers in the UK and elsewhere, such as M&S, Next and supermarkets who all rely on a buoyant consumer. The second half of the year could be a tough trading environment.

This week also sees the start of the Magnificent 7’s earnings season. Alphabet and Tesla report results on Tuesday night. They are a better test of whether AI investments are paying off and if there is consumer demand for AI, compared to the chip makers like Nvidia, who only provide the hardware for the next ‘industrial revolution’ and are likely to continue to see mega profits for the foreseeable. Thus, this week is the start of a very big test for AI. It is also a major test for the market. Can the market rally be sustained if AI starts to wobble? Google and Tesla earnings reports could give us the answer to this crucial question.