Dear Friends,

I hope your weekend was a good one.

Global equity markets have pulled back slightly so far in August. The past few weeks have been marked by the U.S. credit rating downgrade by Fitch, one of three leading rating agencies. Although we foresee limited near-term consequences, we share its concerns regarding U.S. debt, spending, demographics, and governance issues. Meanwhile, recent U.S. economic data continued to indicate solid albeit slowing employment growth and easing inflation. Below, we discuss the second quarter earnings season, which has now wrapped up.

There are a few reasons we evaluate earnings trends. First, we strive to harness the compounding effects of dividends and earnings streams from the equity in our clients’ portfolios, as these tend to drive long-term equity returns. Secondly, earnings results and insights gleaned from the commentary of management teams across various sectors often help us to assess the state and direction of the business environment.

The bulk of U.S. companies have now reported their results. The earnings growth rate for the U.S. equity market for the second quarter looks to have been a decline of roughly 4% year-over-year. This marks the third consecutive quarter of relatively weak earnings results, contrasting with the robust growth from late 2020 to 2022. Nevertheless, as with the last few quarters, the results surpassed low expectations. While inflation poses less of a challenge than last year, management teams expressed continued vigilance about cost containment. Several companies suggested that economic uncertainties are making investment and capital spending decisions challenging. Still, many businesses highlighted a stable domestic economic backdrop, with signs of weakness few and far between.

The banking sector is particularly revealing as a gauge of economic health because banks directly service the consumers and businesses that drive the economy. The earnings results from the banks were positive, even for the smaller regional banks that had been strained by deposit outflows earlier this year. Most banks expressed comfort about the consumer, suggesting households are in good shape with deposits that remain elevated, spending that is gradually slowing, and rising credit card balances – reflecting a normalization of trends according to many management teams. Meanwhile, commercial loan demand has slowed, which is not too surprising given the increase in interest rates and the many companies that took advantage of low rates over the past few years to pre-fund their future cash needs. Lastly, credit losses are slowly rising in certain loan categories, but remain below historical averages. Many banks raised their provisions for future credit losses, yet very few indicated that they were seeing anything concerning.

In summary, the most recent results and commentary suggest a healthier than expected operating environment. As time goes on, we remain cautious about potential vulnerabilities for consumers due to higher borrowing costs. But admittedly, the resilience demonstrated to date continues to be surprising. Any deterioration in the backdrop, should it occur, may still take some time to develop. In the meantime, we want to be prepared for a range of potential outcomes by ensuring all of the allocations within our clients’ portfolios are appropriate.

Have a great week.

Best Regards,

Frank