Low expectations surpassed during second-quarter earnings season

There is no summer lull when it comes to corporate news flow. The second-quarter earnings season in the US is in full swing, with roughly 25% of the S&P 500’s market cap having reported results already.

So far, corporates have largely met the subdued expectations. They almost always do, as companies are adept at managing expectations. However, the number of beats vs misses – the so-called beat ratio – is higher than the historical average. So far, 75% of companies are beating expectations, which is higher than the 10-year average of 73%.

Information technology (IT), communications, and healthcare are surprising most positively, while financials and materials have the lowest beat ratio. In aggregate, earnings for the S&P 500 are tracking 6.4% a beat so far, in line with the 10-year average, mainly due to better-than-expected operating margins.

Looking forward, the guidance of corporates for the second half of 2023 has been surprisingly strong: there have been 1.6x more companies with above-consensus guidance versus below-consensus guidance. Interestingly, companies that missed expectations saw their stock price increase on average by 1.4%. This indicates that investors are looking beyond the temporary weak results and are focusing on the recovery ahead.

We continue to see positive signs for earnings over the remainder of the year. Comparables will get easier after a difficult first half of the year and the US dollar will start to translate from being a headwind into a tailwind for the second half of the year. Overall, we recommend staying invested, with a focus on quality growth (IT, communications) coupled with some defensive plays (healthcare, Swiss equities).

Plenty of catalysts for equity markets this week

Next to the avalanche of earnings reports, this week has crucial central bank meetings. We have the two most important central banks making interest rate decisions. For both, we expect another 25 basis-point hike. For the Fed, this should be the last in this cycle – or simply put, ‘one and done’. The ECB will hike by 25 basis points as well, and there is the risk of another hike in future. The ECB started to hike later, so it is only sensible to assume that they have not yet finished their work. The Bank of Japan will finish off the week with their take on rates. No change is the most likely outcome here.

Mexican equities outperforming but more attractive opportunities elsewhere

Staying with the equity markets, Mexico has been experiencing a remarkable run. The USD-denominated benchmark index has outperformed emerging market (EM) peers in 2021 (+25.2%), 2022 (+18.2%) and year-to-date (+20.9%) – three consecutive calendar years of superior returns can be considered a rare occurrence.

Nevertheless, it is the currency that has been the primary driver behind this outperformance. Almost 60% of the equity market gains since January can be attributed to a stronger peso. In local currency, the equity market has, in fact, shown weaker returns compared to EM peers since the global lows in October.

Going forward, we believe the risks look fairly balanced in both directions. On the upside, Mexico looks attractive for EM investors as geopolitical tensions are low, EPS growth is relatively solid (+7.6% over the next 12 months), and industrial production as well as the manufacturing purchasing managers’ index remain resilient (June: 50.9). On the downside, although equities became cheaper, the market is still rather expensive (vs peers and historical averages). Plus, the strong MXN and a potential pullback could strongly weigh on performance.

As a result, we maintain a Neutral rating for Mexican equities. For investors seeking equity exposure in Latin American, we reiterate our preference for Brazil and Chile (both Overweight), given discounted valuations, continued political improvement, and the start of a strong easing cycle.

Spanish elections trigger uncertainty but economy showing positive dynamics

Elsewhere in the Spanish-speaking world, Spanish voters went to the polls over the weekend in an earlier-than-planned general election following the defeat of Prime Minister Pedro Sánchez’s socialist Partido Socialista Obrero Español (PSOE) to the conservative Partido Popular (PP) in regional elections in late May.

Spain is experiencing a shift to the (centre) right, partly following the trend in other countries across Europe. However, this shift remains incomplete at this stage. PSOE won 122 out of 350 seats in the lower house while PP secured 136 seats. The PP is still short of the majority needed even with the support of the far-right Vox party. As such, government formation is likely to be a lengthy and complicated process and a repeat of the elections remains a possibility.

In terms of the economic agenda, a new centre-right government would be expected to focus on medium-term fiscal consolidation and tax cuts, while another term for the current government implies a continuation.

Overall, Spain’s economy is currently outperforming that of the eurozone in general, following the steep downturn at the onset of the pandemic crisis. Moreover, the country shows quicker disinflationary dynamics than in other European countries.

A still possible change in leadership and additional focus on fiscal discipline might further support the current spread-tightening momentum for sovereign debt, which is now likely to experience a break during the political uncertainty triggered by the elections.

We nevertheless keep our positive view on Spanish government debt and our Overweight rating on the eurozone periphery more broadly, despite the challenges – also outside the political sphere – ahead. Meanwhile, we remain Neutral on Spanish equities as the macroeconomic backdrop and earnings expectations remain less supportive.