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Investors should keep watch on U.S. earnings in coming weeks.

Why to keep eyes on U.S. earnings

Once again, markets are roiling. As with so many sell-offs, this is a story of pressure building steadily until it must vent.

Volatile markets are here to stay. But the next few weeks will tell us whether this episode is a sign of something more ominous to come or just another bump in the road.

The catalyst to the current shedding of equities has been the rise in U.S. Treasury yields. Specifically, it is Treasuries breaching the 3.2% barrier, a level that is psychologically rather than necessarily economically significant.

The increase in Treasury yields has gathered enough momentum to make investors worry that they could soon start to hurt equity markets. According to surveys, this doesn’t start to happen until yields are around 3.5% to 3.6%.

We are not at these levels. But the mere fact that we are approaching them has been enough to unnerve investors, causing them to sell equities.

This panicked response tells us something about the context in which we’re operating. Investors have been getting gradually more and more concerned about what the U.S.-China trade war means for companies and economies at a time when global growth appears to be slowing.

There are a lot of political clouds on the horizon, adding to the uncertainty.

There are a lot of political clouds on the horizon, adding to the uncertainty. Among them are Brexit, the fragile situation in Italy and next month’s mid-term elections in the U.S. Bond and currency markets do not tend to take kindly to uncertainty and usually react with a knee-jerk sell-off.

Experiencing technical difficulties

Some technical aspects of financial markets are also in play, contributing to the aggression of the sell-off. U.S. earnings season kicks off in earnest next week.

Companies tend to be very conservative in their interactions with financial markets in the run-up to the event. Among other things, this means many of the share buyback programs that have driven equity markets lately have stopped, taking the wind out of investors in the process.

Another technical element is that autumn tends not to be conducive to equity market returns. Researchers have spent decades trying to work out exactly why this is the case, largely to no avail.

But it is none the less a superstition that is borne out by evidence. Long-term data show autumn months tend to bring depressed returns, no matter what the cause.

All about the earnings?

In the next few weeks, the U.S. earnings season could tell us whether this sell-off will persist or whether it just another wobble.

Earnings per share are expected to grow by around 20% for the companies of the totemic S&P 500 Index and underlying trends are healthy.

Companies are benefitting from strong consumer spending and the tax windfalls that came courtesy of President Donald Trump earlier in the year. Investors often buy equities for profit growth, so if profits are strong, it may help to soothe their worries.

But there are some risks out there for U.S. companies.

One of these is the strength of the dollar and the extent to which this may erode overseas profits. Another is the lack of a sustained pick up in U.S. wages despite strong employment and intensifying competition for workers.

Finally, there is the worry that higher oil prices may increase input costs. Consumer demand could be hit by higher prices at the petrol pumps.

These risks make the guidance that we will get from U.S. companies in the coming weeks extremely important. It should tell us how alert businesses are to these concerns, as well as what they intend to do with their cashflows.

Guidance should also provide some information on appetite for investment and whether issues like the U.S.-China trade war are affecting corporate behavior. If companies are looking to invest in capital expenditure, for instance, that could help fuel future growth and investors would take this well.

Equally, share prices could be buoyed (at least in the short term) by evidence that companies are planning on supporting their equity stock by restarting buyback programs.

Vying with volatility

Even if this moment passes without incident and a strong earnings season puts the spring back in investors’ steps, volatility will remain.

While years of quantitative easing and ultra-low interest rates all but drowned it out, the U.S. Federal Reserve’s (Fed) plan to raise U.S. interest rates and reduce its balance sheet means that more is inevitable.

These bouts of volatility are not necessarily episodes to fear, though. They uncover pockets of value that are opportunities to buy undervalued assets. Right now is the time for steady hands.

Important Information

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

This article was originally published in Financial News on October 11.

ID: US-151018-74790-1