August 11, 2023
Global equity markets have declined slightly so far in August, aided by the U.S. credit rating downgrade by Fitch Ratings, one of three leading credit rating agencies. Although we foresee limited near-term consequences, we share Fitch’s concerns with U.S. debt levels, persistent over-spending, demographics, and governance issues. At the same time, recent U.S. economic data has continued to reflect solid but slowing employment growth and easing inflation. Below, we discuss the second quarter earnings season, which has now concluded.
Corporate earnings trends are important to the long-term performance of equity portfolios. The compounding effects of dividends and earnings drive long-term equity returns. In addition, earnings results and insights gleaned from the commentary and forward guidance of management teams across various sectors assist in our assessments of the condition and direction of the business environment.
The earnings growth rate for the U.S. equity market for the second quarter appears to have been a decline of roughly 4% year-over-year. This marks the third consecutive quarter of relatively weak earnings results, contrasted with the robust growth from late 2020 to 2022. Nevertheless, as with the last few quarters, the Q2 results surpassed analysts’ low expectations. While inflation poses less of a challenge than it did 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 few signs of weakness.
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 confidence in consumers, suggesting that 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 expect to remain cautious about potential vulnerabilities for consumers due to higher borrowing costs. The resilience demonstrated to date continues to be surprising. Any deterioration in the economic backdrop, should it unfold, may still take some time to develop. In the meantime, we will be prepared for a range of potential outcomes by ensuring that the allocations within our clients’ portfolios are appropriate.
If you have any questions, please do not hesitate to contact us.
Drew M. Pallett LL.B. CFP
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities
Email: drew.pallett@rbc.com
Website: www.pallett.ca