Amidst all the geopolitical gloom, there’s plenty of light too – in the form of strong Q2 2018 corporate earnings in the U.S. and elsewhere. But are buoyant markets being blinded by earnings growth, and not facing up to some major problems ahead?


1. U.S. Q2 corporate earnings growth has been very strong – but other regions have been doing well too.

With the U.S. Q2 earnings season now drawing to a close, the results have beaten even optimists’ expectations: with ~88% of S&P 500 companies having already reported, earnings growth is running at 25.5% YoY, 81% of companies have beaten expectations and revenue growth has been very strong too. We look in more detail at the U.S. results on page 2, but these are only part of the story. As we discuss on page 6, Q2 corporate earnings have been strong in many other markets too: with ~54% of companies having now reported, MSCI AC World earnings growth is 20.4% YoY with strong emerging markets expansion (although European earnings expansion has been relatively muted.)

 

2. Markets may also have been reassured by strong U.S. guidance, although expectations could be scaled back.

All this light around earnings sits uneasily with a difficult geopolitical global backdrop. Over the last week, we have seen a further escalation of trade tensions between the U.S. and China, and the announcement of U.S. sanctions against both Iran and Russia. These sanctions could be disruptive and, even under the most optimistic scenarios, rolling them back could take some time. So why are markets not more perturbed? One possibility is that earnings results are seen as reality, rather than simply a future threat. Markets have also been reassured by strong guidance from U.S. firms, although it is worth remembering that even the biggest, most astute firms can’t predict the future. The markets’ earnings expectations around some European sectors (e.g. financials, materials and oil and gas) also look rather too upbeat.

 

3. But with complex issues now vying for the markets’ attention, deepening shadows will push up volatility.

But perhaps the real reason for some markets’ resilience – so far – is the sheer complexity of the issues that they have to assess. For almost a decade since the start of the Global Financial Crisis, their focus has been on the implications of tweaks to government monetary policy. But now, with the U.S. earnings season almost over, they have to consider the implications of tariffs (China, Europe), trade sanctions (Iran, Turkey) and classic emerging market blow ups (Turkey). There are also significant political risks in Europe (Brexit, Italy) and possibly around the U.S. mid-term elections. With all these issues vying for the markets’ attention, volatility is likely, even with continued global earnings and GDP growth. This may support the case for a tactical approach to investing in gold, as we discuss on page 8. The shadows are deepening, but there will be light amongst the dark.

 

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CIO Office, Deutsche Bank Wealth Management, Deutsche Bank AG - Email: WM.CIO-Office@db.com