Company earnings reports for the second quarter (ended 30 June) continued to roll in this week, indicating the US economy is still in sound shape. Eighty percent of the S&P 500 companies that have reported earnings so far have beaten their estimates, although earnings per share (EPS) in aggregate have declined 5.2% year-on-year, the third straight quarter of EPS declines.
While the strong stock market performance in the first half was driven largely by the macroeconomic news of subsiding inflation and a pause in Fed interest rate hikes, the second half is likely to be more about the performances of individual companies and specific sectors. Optimism about a soft economic landing is already largely priced into the markets and so companies need to surprise on the upside to show strong gains.
Investors are paying attention not only to earnings growth, but also to companies’ forecasts and outlooks. That’s why we saw Apple stock tumble on a weak outlook despite good results, while the likes of Alphabet and Meta have shown strong gains. As this illustrates, we can expect to see earnings and stock price gains starting to diverge between companies even within specific sectors like technology.
Whereas passive investments that follow the indices showed excellent performance when macroeconomics set the pace, we are now entering an environment that may favour investors who tend to focus on concentrated portfolios reflecting their views of conviction on stocks, sectors, and financial metrics.
Quality managers will seek companies with strong underlying cash-flows, consistent earnings that are relatively resilient in volatile markets, and where each business has significant pricing power and competitive advantages. While active funds often underperform when markets are running hot and fast, our preferred quality style, of actively managed funds tend to outperform when benchmark returns are cooler or negative.
Dynasty’s portfolios include both passive and active management components because we recognise that it is both macroeconomic conditions and individual company performances that dictate risks and returns. Our approach is designed to protect clients from volatility, while also enabling them to capture growth over full market cycles.
As we look to the second half of the year, analysts are forecasting benchmark EPS growth to be 0.8% for the year, with a 7.6% earnings increase from Q4 2022 to Q4 2023. At the same time, many companies within our concentrated portfolios are anticipated to grow their cashflows by around 10% per annum on average over the next 5 years. Following excellent global index performances for the first seven months of the year, we now expect more muted returns going forward. In this environment, it could well herald a season of differentiated individual companies’ earnings and prospects.
“Good sectors and businesses remain good and poor return businesses also have persistently poor returns.”
– Fundsmith MD, Terry Smith
Global News
- The US Core Consumer Price Index (CPI) rose 0.2% for a second month, marking the smallest back-to-back gain in more than two years, according to the latest data from the Bureau of Labor Statistics, which was released on Thursday. This bolsters hopes that the Fed can tame inflation without sparking a recession.
- US Bank stocks fell on Tuesday after Moody’s downgraded 10 small and mid-sized banks and placed several larger banks on review for downgrades. Moody cited higher funding costs, potential regulatory capital weaknesses and rising risks tied to commercial real estate. This suggests that banks remain vulnerable to the problems that stirred a panic after the failures of Silicon Valley, Signature and First Republic earlier this year.
- A combination of higher interest rates and renewed restraint in government spending is threatening to strangle expansion and raise the risk of a recession in the Euro Zone. The delayed pain from hikes in borrowing costs that began last year will increase in 2024.
- The Bank of Russia will stop buying foreign currency on the domestic market for the rest of 2023 to help the ruble and reduce the volatility of currency markets as the coinage slumped toward 100 per dollar, a level last seen in the first month after President Vladimir Putin invaded Ukraine. The ruble has weakened by about 24% against the dollar so far this year.
- Weight-loss drugs Ozempic and Wegovy propelled Novo Nordisk, to the second wealthiest company in Europe behind French luxury giant LVMH. (Novo Nordisk is a top 10 holding within the Fundsmith Equity Fund). However, the healthcare company – whose products have been lauded on TikTok videos and by Elon Musk – is struggling to keep up with demand.
- Billionaire Warren Buffett’s Berkshire Hathaway exceeded expectations in the second quarter, largely driven by a 74% increase in insurance underwriting earnings as it trimmed expenses at auto insurer Geico and benefited from its acquisition of underwriter Alleghany.
- WeWork’s dire warning that it may fail as a business sent its shares down more than 25% in extended trading yesterday. Its potential collapse is due to sustained losses and canceled memberships for its office spaces due to the increase in the work-from-home trend, which came to the fore during the COVID-19 Pandemic. WeWork, valued at $47 billion in 2019, is now just worth $270 million.
- As at Thursday’s close the S&P was 0.2% down for the week.
Local News
- South Africa’s government is developing a framework that will guide how coalition governments should be constituted and operate, which should help stabilise fractious municipalities and ensure national and provincial administrations aren’t derailed by infighting in the event that there is not an outright winner in next year’s elections. With the possibility of a coalition in the national government next year, smaller parties will be contesting the ANC and DA in the courts for seats in the house.
- Lady R did not load local weapons or ammunition when it called at the Simon’s Town Naval Base in December last year but collected food and other supplies for its return trip to Russia. This is according to a source based on the findings of a government investigation. Government has yet to decide what action to take against US ambassador Reuben Brigety, who alleged that South Africa had supplied Russia with weapons.
- South African President Cyril Ramaphosa has pardoned thousands of non-violent offenders, including his predecessor, Jacob Zuma, who was convicted of contempt of court. Zuma’s incarceration in 2021 triggered the worst riots in South Africa since the end of White-minority rule, leaving 354 people dead and thousands of businesses destroyed.
- The ongoing taxi strike in the Western Cape, which was set to end today, came to a conclusion overnight after there was a resolution to look at the release of the unlawfully impounded taxis. Stephen Grootes believes that this issue goes deeper than what it appears to be on the surface.
- The rand’s performance in recent weeks has, once-again, reinforced the fact that it remains inherently volatile, but also that it is prone to bouts of significant weakness until the economic management of the country improves substantially. While it recovered strongly in June and July, partially thanks to a temporarily weaker dollar, it lost over 6% in the first nine days of August.
- Nedbank expects that the South African Reserve Bank will keep rates unchanged for the rest of the year. The Reserve Bank paused its interest rate hiking cycle in July after 10 consecutive hikes.
- The JSE has recorded outflows of R65 billion year-to-date, compared with a figure of R42 billion for the same period last year due to poor investor sentiment and the relaxing of retirement funds’ offshore allocations, according to RisCura.
- An increase in load-shedding could cost the economy about R400 billion more this year than in 2022, wiping out R77 billion in tax revenue. The effect on the value-added approach to GDP, or gross value added, is projected at R725 billion. Absa forecasts a revenue shortfall of R39 billion, from R25 billion previously when compared with the 2023 budget target.
- Coronation’s tax case, over whether it owes the tax man more than R700 million because SARS believes that its offshore entities’ profits should also be taxed locally, could head for the Constitutional Court as it appeals an earlier decision. The Draft Taxation Laws Amendment Bill proposes codifying the Supreme Court of Appeal’s decision (the one Coronation is appealing now) which could leave a whole range of offshore structures ‘very vulnerable’.
- As at the time of writing, the rand was 2.1% weaker and the ALSI was 0.4% stronger for the week.
Sources: Dynasty, Daily Investor, Daily Maverick, Bloomberg, BusinessLIVE, BusinessTech, IOL, News24, BizNews.com, Analytics Consulting FX Solutions, Moneyweb, NYT, etc.
