UBS deal a cathartic moment for AT1s
As earnings season ends, we take stock of the latest US results and what it tells us about the health of corporates, the consumer, and the outlook for the broader economy.
Thus far, US earnings and commentary from management teams have presented a bit of a mixed bag. Coming into earnings season, 2023 S&P 500 consensus estimates were 13% below peak 2022 levels, representing somewhat of a ‘lowered bar’. But, with over 90% of the S&P 500 having reported, 82% have published earnings better than expectations, according to Bloomberg.
These are healthy levels consistent with what we’ve seen in previous quarters this year. What causes some concerns, however, are the trends we are seeing on ‘top-line’ sales – fewer companies are beating consensus sales expectations with a deceleration of sales growth on a year-over-year basis. In the third quarter of this year only 49% of the S&P 500 topped lowered-bar sales expectations, down from 69% in the first quarter (Bloomberg).
This message largely echoes much of the commentary we are hearing from US management teams this earnings season. According to Bloomberg, mentions of “weak demand” on earnings calls was near the second highest on record over a 15-year time horizon. Looking at a cross-section of US corporates, spanning multiple industry sectors, we observed a similar cautious tone from a bottom-up perspective.
On numerous occasions, transportation company UPS, who many view as a leading barometer of the broader economy, noted a “weak global macro” and “softer global demand”. Referring to their “top-20” customers, management noted reports of “declining sales” and themes of “guiding softer”. To “reflect the uncertainty in the market,” the company lowered guidance, which fell shy of analyst estimates.
Financial services bellwether Mastercard also revealed some key insights relating to the health of consumers worldwide. For the quarter, the company turned in solid results, marked by strong gross dollar volumes (+11% year-on-year) across its credit and debit card business, as management observed “continued resilience of consumer spending”. However, there were hints of caution in their fourth quarter outlook, which disappointed versus consensus expectations. Noting elevated “macroeconomic and geopolitical uncertainty,” Mastercard’s management disclosed they were closely monitoring “credit availability and savings behaviours”.
Separately, industrials giant Caterpillar, a gauge of manufacturing activity globally, offered a similar reason for pause. While strong quarterly results exceeded estimates, many investors were surprised by a negative pivot in the company’s order backlog. After registering multi-billion-dollar year-on-year growth in order backlog the previous three quarters, Caterpillar reported an unpleasant reversal as its third-quarter order backlog turned negative by $1.9bn compared to the previous year. While cautiously optimistic, management said that they “continue to closely monitor global macro conditions”.
So, what does this mean for the broader US economy? Currently, corporate profits remain healthy and company balance sheets are strong. In the past quarter, the US registered very strong GDP growth of 4.9%. However, looking forward, we see signs of moderation to growth and softening in the data to come, which has been confirmed by the somewhat bearish tone from management teams in the earnings season.
In other words, we are seeing increased evidence from the micro level that the strong macro-economic data is likely to weaken. While some slowing of growth is expected, we note that it will be moderating from very strong starting levels. As such, we continue to favor a balanced and diversified “up-in-quality” portfolio of credit with strong starting yields, along with exposure to US treasuries that should perform well while growth decelerates. This portfolio should provide investors with an opportunity for attractive risk-adjusted income and capital appreciation over the medium term.