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US reporting season look ahead

The US reporting season has come at a crucial time as stocks are relatively cheap, but they have fallen for a reason.

American flags
Source: Bloomberg

Investors are cautious ahead of this reporting season as the poor stock market performance at the back end of last year has creeped into 2016. The trend of previous reporting seasons in recent years is that fewer companies are exceeding their expectations. Macroeconomic themes, like the slowing down of the emerging economies, the collapse in the commodity markets and the strong US dollar will keep playing their part in the reporting season. Even though there a select few stocks that are rallying regardless, there is a feeling this reporting season will be a turning point as the broader market is delicate.

Some equity markets hit an all-time high in 2015, including the Dow Jones and the S&P 500. The record highs were not driven by excellent fundamentals, but more the willingness of central banks to operate loose monetary policies, with the European Central Bank’s stimulus package being a key driver for eurozone markets.

The rallies in the Dow and the S&P 500 both began to wane in the second-half of the year and both indices printed negative returns by the year’s end. Finishing in the red after hitting record highs is concerning, and so far investors have opted not to buy the dip, but rather wait until reporting season gets underway.

US equity markets spent the bulk of 2015 being rangebound, having never really recovered from August’s ‘Black Monday’. The Dow Jones and the S&P 500 were plateauing before the summer crash, and both failed to make up the lost ground since. The bull run that global stock markets experienced in the wake of the credit crisis started in the US, and now it appears to be running out of steam. With the exception of the DAX, the Dow Jones and the S&P 500 easily outperformed the major indices in the eurozone (between January 2009 and December 2014) and now it seems the US equity rally is cooling.

Positive projections for 2016
The last reporting season (16 August until 15 November 2015) saw just under 44% of companies in the S&P 500 exceed their revenue estimate, and nearly 74% posted higher than anticipated earnings per share figures (EPS). Healthcare, telecommunication and technology stocks outperformed the market in terms of the percentage of companies beating revenue and EPS expectations. Oil & gas and basic material stocks underperformed on the revenue front but did very well on EPS.

With the US economy being relatively strong, investment banks have higher estimates. In the aftermath of the credit crisis, a much higher percentage of companies were topping, but this was partially thanks to the low levels of estimates. A number of firms exceeding their expectations dwindled in 2015, but according to Bloomberg we are anticipating a higher percentage of companies to beat revenue and EPS forecasts in 2016.

S&P 500 companies that have exceeded revenue estimates
S&P 500 companies that have exceeded EPS estimates

Fear the FANGs
The US stock market finished the year on negative note, but there were a handful of stocks which had spectacular performances. Traders love their acronyms, and when it comes to blue chip US equities, the FANGs (Facebook, Amazon, Netflix and Google – now Alphabet) are all the rage.

It is worrying when investors become fixated on a handful of stocks especially when the broader market is failing to advance. It is dangerous to ignore the big picture and devote your funds to a small selection of share as it suggests investors have become blinkered in their vision. The stock market is survival of the fittest, and shares that slip in value or trade sideways get dropped and the few star performers attract even more money, and that exacerbates their uptrend. The major sell-offs in the 1970s and after the dot-com boom also experienced a similar pattern where investors began to focus on a smaller number of equities. 

  1-year capital return 3-year capital return
Dow Jones -7.1% 21.4%
S&P 500 -5.2% 31%
Facebook 26% 209%
Amazon 106% 128.5%
Netflix 138% 676%
Alphabet (A line) 46.4% N/A

 

The higher capital returns also comes at a high risk as the FANGs come with high valuations and zero dividend to fall back on. The parent company of Google – Alphabet – has ratios that would make some investors nervous and that is the best of the bunch in terms of the multiples. Even for a tech stock, Alphabet is highly valued going using the numbers below. 

  Forward 12M P/E FY price/book value FY dividend yield
Dow Jones 14.1 2.72 2.87%
S&P 500 15.42 2.4 2.44%
Facebook 36.8 6.64 N/A
Amazon 136.67 22.99 N/A
Netflix 654.09 22.05 N/A
Alphabet (A line) 21.88 4.3 N/A

 

Flight from stocks?
The Federal Reserve finally increased interest rates at the back end of last year, and Ms Yellen stated the US will increase interest rates four times throughout 2016, and each will increase will be a 25 basis points hike. Following the FOMC minutes we know it was a ‘close call’ whether to lift-off or not, as some Fed members were concerned the inflation target would not be achieved. With that in mind, pushing interest rates 1% higher by the end of the year seems less likely, and the Fed Funds futures market is pointing to two 25 basis point increases this year.

The strength of the dollar was a concern in recent reporting seasons and the problem will only get worse for US exporters as talk of more interest hikes will keep the greenback in demand. US companies that depend on overseas business are also being hit by the loosening of monetary policy that dozens of central banks are undertaking. For too long the stock market was the obvious choice for investors, as returns on bonds and cash accounts were so low, but now the Fed is starting out on a cycle of rate hikes, we could see an exodus from equities especially when the return from indices barely cover the cost of inflation.

Stocks are that bit cheaper as the concerns over Chinese market volatility has gone away for now, and as we enter into the US reporting season it could tempt traders back to the market. The projections from Bloomberg about future earnings are positive, which will ease investors’ concerns, and strong updates from firms will overshow short-term spikes in volatility. Traders should be guarded when investing in the FANGs as they look impressive, but they are also razor-sharp, and if you get bitten it will be painful. For now the US monetary policy won’t be a major issue for firms, but looking to further easing seasons this year, the Fed’s actions or inactions will have a higher impact on the individual companies, but also on the overall investment market.

The FANGs are available for extended hours trading.

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