Serious Money: Energy and telecoms are key sectors where US companies are beating expectations, suggesting correlative European outperformances
The US equity market, like so many other things American, dominates the rest of the world. Investors everywhere always start their decision making process with a discussion about the prospects for US stocks.
Historically, the region most closely correlated with the US is Europe. But high correlation does not necessarily mean perfect correlation: in the year to date, for example, the US market is essentially flat, whereas German and French equities are up around 15-16 per cent. By contrast, the market most likely to do its own thing is Japan, where historic links with the US are fairly low. If we can guess the likely direction of US stocks we will have a good starting point for our own markets.
If anybody needs to understand why equities have been having such a good run, they need look no further than the US. We are coming to the end of the quarterly reporting season for profits and we are again faced with the unusual situation where stock analysts have been proved to be far too pessimistic about corporate earnings. Companies are beating analyst estimates - sometimes by a mile. In aggregate, according to Thomson Financial, analysts at the start of July thought that S&P500 profits would rise by 6 per cent in the second quarter compared to a year previously. As many companies have reported blow-out numbers, that estimate has already risen to 11.1 per cent - a rather big miss by analysts.
Of the 370 companies that have reported at the time of writing, 69 per cent have beaten expectations. Now, some of those have bettered analyst forecasts by a tiny amount - the usual corporate expectations management exercise. But when we allow for the games that companies play with Wall Street, we still see that the people who paid huge sums of money to follow corporate America have got it badly wrong. And the stock market has responded in an eminently sensible fashion by pushing up the prices of those stocks that have reported the strongest profit increases.
Not surprisingly, one group of companies that is consistently reporting super profitability is the energy sector. Last April - not so long ago - analysts were forecasting a second quarter profit increase of 13 per cent compared to the same quarter a year ago. With three-quarters of companies in the sector now having reported, it now looks as if growth will come in at around 41 per cent. That's not just an analyst error - if it had been the other way around (over-optimism) I suspect we would have heard a few litigious Americans talking about suing one or two of the culprits.
For some reason, investors are more forgiving of analysts who err on the side of pessimism. Perhaps it's a reaction to the irrational exuberance of the bubble years.
Regular readers will know that the oil stocks, including many European names, have long been a favourite of Serious Money. I've been toying with the idea of taking some money off the table, thinking that the idea that oil prices staying high must now be fully reflected in analyst forecasts. Looking at the kind of mistakes that they are still making, I'm not so sure: there could still be plenty of money in oils.
A well-known, if controversial, US oil company is Halliburton. It earned 76 cents a share in Q2, compared to a consensus estimate of 56 cents. (Politically minded readers might be interested to note that $48 million (€39.3 million) of the $392 million reported quarterly profits came from Iraq-related work.)
Other oil companies have reported similarly strong numbers: ExxonMobil beat expectations by 40 per cent, ConocoPhillips by 53 per cent and Chevron by 15 per cent.
Another sector doing well, although in a slightly less high profile way than oils, is telecommunications. SBC, Sprint and AT&T all beat estimates by 16-17 per cent. Investors in European telco stocks have started to take notice and the sector has begun to edge up: if the US is anything to go by - and it usually is - European telcos could have only just begun a good run. Whether or not investors share my longer term doubts about the sector (competition, regulation, VOIP, etc), the next few months could well be profitable ones for investors in companies like BT, DT and FT.
Back in the US where the wheels are falling off - if I can be excused an awful pun - is in the auto sector. "Consumer discretionary" stocks have seen their earnings drop by around 3 per cent for the quarter. But all of the action here was concentrated in auto stocks: take car makers out of the equation and companies exposed to cyclically sensitive consumer spending increased their earnings by 14 per cent. Who said the US consumer was dead? What lessons can be drawn from all of this? First, as I have already mentioned, it may well be the case that we continue to run with the bet on oils. Sometimes the simple strategy is the best. Telcos continue to look interesting, albeit perhaps only tactically for a quarter or two. Suggestions that tech spending is about to get a lift from a replacement cycle might also encourage the bulls of that sector.
But if US profits growth has surprised the analysts, it is in Europe where the biggest surprises may yet come. European corporates have also consistently beaten expectations over the recent past but valuations do not suggest that markets expect this sparkling performance to be maintained for very long. If by this time next year we are still talking about positive earnings surprises in Europe I suspect we will also be remarking on the surprising robustness of the equity bull market. And the European consumer may be the biggest surprise of all.
Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.
