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Fundamentals driving markets higher
05 Jun 2024

During the December Central Bank meeting, the US Federal Reserve cemented expectations of monetary policy easing in 2024. Since then, equity market sentiment and risky assets have delivered positive returns. Strong and fast rallies suggest caution; however, equity markets have continued to march higher in 2024. A look at key economic indicators and learnings from earnings season indicates that fundaments are supporting the current market positivity.

US equity markets performance has so far been driven by the technology sector. Companies that benefit from Artificial Intelligence (AI) growth trend continue to outshine. In contrast, Europe equity market performance has underperformed, but delivered a wider market breadth across the technology, consumer discretionary and industrials sectors.

Around one third of the US equity market is represented by seven companies. With the US equity market rally dominated by a few names, concentration risk has also increased. US Big tech are worth around $13 trillion in market cap, and Nvidia surpassed Amazon and Alphabet following a 60% increase in its share price since the start of the year. This has led to many bubble warnings around the AI theme that is powering strong interest across the so called “Magnificent 7”.

Strong earnings performance across key players suggests that this is more than momentum. Earnings seasons offer a bottom-up view of the economy and an opportunity to reconcile market pricing with companies’ financials and expectations. With over 90% of US listed companies have reported, key insights can be derived from the first quarterly earnings.

US listed equities have delivered positive earnings growth compared to an overall decline in profitability by European listed equities. Despite the decline, European earnings came in better than expected. More importantly, company guidance shifted positively compared to past quarters. Capital returns, in the form of dividends and share buybacks are also improving, with financials offering strong payouts.

The resilience of US companies’ sales and profitability is in line with its top-down economic view: the US as a positive outlier compared to major economies. The US economy remains boosted by strong domestic consumption and employment, notwithstanding the current tight financial conditions. At company level, average US earnings surprise is above 7%, with both sales and earnings growth exceeding expectations. The beat was broad, with 76% of companies surprising on earnings. Average earnings growth also stood above 7%, with eight out of the eleven sectors reporting a yearly increase. The strongest expansion in profitability was captured by the communication services, consumer discretionary and technology sectors.

More importantly, earnings grew by an average of 58% across semiconductor players, with Nvidia and Intel leading the industry growth. The strength in profitability beats the index level by a wide margin and continues to support the monetisation of the AI trend across the leading players. In addition, earnings growth surprised by 11%. This demonstrates that the strong price upside across US technology names is largely driven by earnings growth, with a much smaller contribution from a multiple expansion.

Despite the relatively weaker earnings season in Europe, the latest round of leading economic indicators shows an upside surprise in activity and an improvement in in the economic cycle. European Purchasing Manager Indices improved steadily in February. The services sector drove the improvement with a recovery to the 50 level after months in contraction territory. The manufacturing side remains weak, with poor manufacturing output in Germany. Even so, the reversal of high inventory levels is a positive indicator going forward. This can be measured by a rebound in new orders to inventory ratio, which carries a high correlation to earnings momentum for export oriented European equities. Together with expectations of rate cuts in the months to come, European equities should benefit from continued improvement in manufacturing activity.

Notwithstanding the support from a central bank pivot, the recent positivity highlights that interest rate sensitivity for equity markets has declined. While valuations are relevant, the focus going forward is whether fundamentals will continue to deliver. If earnings and economic fundamentals hold, the interest rate outlook will matter for bonds than equity markets.

Rachel Meilak, CFA is a portfolio manager at BOV Asset Management Ltd. The writer and the company have obtained the information contained in this document from sources they believe to be reliable, but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the Company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof if any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate. If you invest in this product, you may lose some or all of the money you invest. The value of the investment may go down as well as up. BOV Asset Management Limited is licensed to conduct investment services in Malta under the Investment Services Act by the Malta Financial Services Authority. Issued by BOV Asset Management Limited, registered address 58, Triq San Zakkarija, Il-Belt Valletta, VLT 1130, Malta. Tel: 2122 7311, Fax: 2275 5661, E-mail: [email protected], Website: www.bovassetmanagement.com. Source: BOV Asset Management Limited.

 

 

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BOV Asset Management Limited is licensed to conduct investment services in Malta under the Investment Services Act (Cap.370 of the laws of Malta) by the Malta Financial Services Authority.