As we get set for what promises to be a rocky earnings season (consensus has S&P earnings falling for the fifth consecutive quarter), let’s take stock of how far we’ve come since Brexit. Here’s a look at global equities:
Not bad, right? UK stocks are up 11% off the closing lows on Monday, June 27. For its part, the S&P has tacked on 7% and, after the overnight euphoria in Japan, opened Monday at record highs.
Meanwhile, the VIX has fallen off a veritable cliff since Brexit Friday’s record move. Here’s the visual from the day following the UK referendum:
(Chart: Goldman)
And here’s what’s happened since:
Now you could, if you wanted to, point to falling Treasury yields and soaring gold and silver prices as evidence that investors aren’t as complacent as the S&P and the VIX make them out to be.
But remember, Treasury yields are being held down at least in part by foreign demand from investors who want risk free assets but can’t stomach negative yields in Japan and Europe. As for gold and silver, there’s a certain extent to which this is spec money chasing a rally. Have a look at positioning:
(Chart: Deutsche Bank, CFTC)
So are stocks pricing in a volatile earnings season? No, probably not. Here’s why we use the term “volatile” in the context of Q2 earnings:
(Chart: SocGen)
As you can see, “results may vary.” Energy is excluded as it’s unquestionably an outlier with expectations for a 77% decline.
Thanks to sandbagging and financial engineering (read: issuing debt and buying back shares with the proceeds) you can expect more bottom line beats than misses, but with the buyback blackout extending throughout the month….
(Chart: Goldman)
...and with valuations stretched (compared both to history and to the rest of the world)...
(Chart: Goldman)
… one wonders if we may be in for a bumpy ride over the next four or so weeks. Here’s Goldman’s near- and medium-term take on equities for what it’s worth:
“We remain Neutral over both 3- and 12-months post the Brexit vote. We think the search for yield may remain supportive to equities as investors are forced further out the risk curve seeking return, but are wary about chasing the post-referendum rally given elevated valuations and continuing political and growth risks. We remain Neutral across regions globally over both 3- and 12-months as signals from valuation and equity risk premia seem distorted, and high- growth regions trade at high valuations but low-growth regions do not seem cheap. Until we see consistent signs of better earnings growth and higher inflation expectations, we believe equities will remain on a ‘fat and flat’ trajectory.”
Notice Goldman’s mention of “distorted” equity risk premia. For those who missed it, we discussed this in detail over the weekend.
So you can draw your own conclusions from the above about how the market is or isn’t priced for the continuation of an earnings recession that’s now entering its fifth month but we will leave you with one final chart to ponder as you assess the prevailing environment:
(Chart: Goldman)
Strap in. Alcoa is up first after the bell.