Weekly Comment

Corporate earnings season for the second quarter of the year will begin in two weeks, with several large banks such as JP Morgan, Citi and Wells Fargo reporting on July 12. Mega-cap technology companies will begin reporting later in the month, most notably NVDA, which will report through August 23.

In this context, the consensus estimates that earnings per share (EPS) of the companies comprising the S&P 500 could grow by 9% annually, which would represent the strongest growth since the 4Q21. Earnings are expected to decline only in the Materials (-11% annually) and Industrials (-1%) sectors. In contrast, the Technology (+17%) and Communication Services (+17%) sectors are anticipated to show the fastest growth compared to other sectors, led by mega-cap tech stocks. Overall, the top six S&P 500 stocks (AMZN, AAPL, GOOGL, META, MSFT and NVDA) are projected to grow their Q2 EPS by 30% annually, while the other 494 companies will grow by 5%.

Another relevant fact is that revisions to consensus estimates have been unusually resilient recently. Typically, quarterly consensus EPS estimates are usually reduced by 7% during the 6 months leading up to the start of earnings season. However, over the past six months, the 2Q24 EPS consensus estimate has barely declined by 1%. Excluding mega-cap tech companies, analysts have cut EPS estimates by 3%.

On the other hand, analysts are forecasting sales growth of 4% annually for the period. With this combination of factors, the companies’ net income margins, excluding the energy sector, are expected to stand at 11.7%, which represents an increase of 58 basis points (bps) annually, albeit only a 14 bps increase quarter-over-quarter (2Q24 vs. 1Q24). The recent slowdown in labor and material costs suggests that this margin forecast could be achievable.

With all of the above, EPS for S&P 500 companies is expected to grow 9% for the full year compared to 2023, with sales growth of 5%. Undoubtedly, the quarterly reporting season that is about to begin will be a near-term catalyst on investors’ radar, given the strong performance the S&P 500 has experienced so far this year.

Consensus forecast for the 2Q24 earnings season (annual growth)

EPS means earnings per share

SPS means sales per share

Source: Goldman Sachs – Facset

Consensus estimate for the 2Q24 EPS growth of +9% is the highest since 2021

Source: Goldman Sachs – Facset

As we approach the start of the second half of the year, we highlight the strong performance of the S&P 500, which has accumulated gains of approximately 15%. This performance primarily reflects optimism around artificial intelligence (AI), resilience in corporate earnings, and expectations of a potential Federal Reserve (FED) reference rate cut. Here are the key events that investors will be watching closely for the remainder of the year:

2Q24 and 3Q24 Earnings Season: Second-quarter earnings season is scheduled to begin during the second week of July, led by JPMorgan Chase (JPM), Wells Fargo (WFC), and Citigroup (C). Annual earnings growth of 8.8% is estimated for S&P 500 companies, marking the highest rate since the first quarter of 2022 (+9.4%). For the third quarter (3Q24), potential growth of 8.2% annually is forecasted, which could lead to an 11.3% annual increase in corporate earnings for the full year 2024.

Other Geopolitical Events: The United Kingdom will hold early elections on July 4, determining the composition of its Lower House, and ultimately the country’s next government. In France, the second round of parliamentary elections will be held on July 7, where the far-right Rassemblement National (RN) party won a historic 31.4% of the vote for the European Parliament, beating the 14.6% obtained by Macron’s party.

Boom in Artificial Intelligence (AI): More than 18 months after the launch of ChatGPT, the growing adoption of AI has significantly boosted the markets. Companies such as Microsoft, NVIDIA, Apple, Alphabet, Amazon, and Meta have contributed 64% of the global stock market’s total return since then. In June, NVIDIA became the world’s largest publicly traded company. This growth suggests that capital expenditure (CAPEX) in AI could continue in the coming months, further strengthening earnings growth for the sectors involved, such as semiconductors, which could grow 50% this year and 25% by 2025. As the AI ecosystem grows, it is estimated that CAPEX for developers could reach US$331 billion by 2027.

Interest Rate Cuts: Slower economic growth and expectations of a slowdown in inflation could lead to further rate cuts by central banks such as the Swiss National Bank, ECB, and Bank of Canada. On the other hand, the Bank of England’s first cut is projected to be in August, and the FED is expected to implement its first 25 basis point cut on September 18.

U.S. Presidential Elections: On November 5, U.S. voters will decide the outcome of the presidential election. Democratic President Joe Biden and former Republican President Donald Trump will face off in key debates scheduled for June and September. Current polls show a slight advantage for Trump, although a significant proportion of voters are still undecided. Historically, election years have tended to generate positive returns in the markets, with the S&P 500 posting an average historical return of 10.1% since 1937.

Some key dates for the second half of 2024

Source: UBS

By the end of 2023, global central banks were poised to initiate significant interest rate cuts. However, as the year progresses, persistent inflation and economic resilience led to a reassessment of these expectations. In this context, we share some of the perspectives they recently conveyed to the markets.

Federal Reserve (Fed):

• Revised projections: Fed Chairman Jerome Powell noted earlier this year that initial projections of multiple rate cuts were too optimistic. The new expectation is for only one or two rate cuts by the end of 2024, rather than the three previously anticipated.

• Economic resilience: Despite inflationary pressures, the U.S. economy and labor market showed resilience, which implies closer monitoring prior to implementing cuts. 

European Central Bank (ECB):

• Monetary policy tightening: The ECB recently made a modest rate cut, although it emphasized a cautious perspective due to continued inflation and economic uncertainty. In particular, its members warned of “bumps in the road” as they navigate these challenges.

• Geopolitical concerns: Events such as French President Emmanuel Macron’s decision to call early parliamentary elections added uncertainty, influencing market expectations and possible forward-looking decisions by the ECB. 

Bank of England (BoE):

• Rate cuts delayed: The BoE postponed on several occasions the anticipated rate cuts, which could materialize in the third quarter of the year, in line with consensus forecasts. This is despite a significant reduction in headline inflation, as steady wage growth keeps the BoE cautious.

As can be seen, the desired 2024 monetary easing cycle has lost momentum, largely due to persistent inflation, particularly in sectors such as services and robust economic activity. Central banks have therefore found it necessary to recalibrate their strategies to a more cautious approach, which could involve more gradual adjustments to short-term interest rates, so that this move allows them to bring inflation consistently toward their long-term targets.

Expectation for the monetary policy of Central Banks in Developed Countries

Source: Capital Group

Prior to the Federal Reserve (FED) announcement, it was reported that May’s inflation decelerated to 3.3% annually, compared to the expected 3.4% and the previous month’s rate. It is important to note that, on a monthly basis, inflation remained unchanged. Core inflation also improved, coming in at 3.4% annually compared to the expected 3.6% and the forecasted 3.5%. In this context, the FED made the unanimous decision, widely anticipated by the market, to maintain the target range for the federal funds rate at 5.25% – 5.50% (its highest level in the last 22 years).

The statement reiterated that the latest employment indicators have shown solid performance, while inflation has decreased over the past year, although it remains elevated. It highlighted that there has been modest progress toward the Committee’s 2% inflation target in recent months. Therefore, the Committee reiterated that it does not expect it to be appropriate to reduce the target range of the reference rate until there is greater confidence that inflation is moving sustainably toward its objective, while remaining very attentive to inflation risks.

On the other hand, the FED updated its macroeconomic outlook, significantly adjusting expectations for possible cuts to the reference rate. It now anticipates only one cut of 25 basis points (bps) for the remainder of the year, down from the March estimate, which suggested the possibility of three cuts (the market had been expecting two cuts). Thus, the federal funds rate would end the year at an average of 5.1%, compared to the current 5.4% and the previously anticipated 4.6%. For 2025, the new estimate suggests that the rate would stand at 4.1%, up from the previously forecasted 3.9%. Regarding the economic outlook, the GDP growth expectation remains at 2.1% for 2024 and 2% for 2025. The unemployment rate did not undergo significant changes for either year, remaining around 4%. However, estimated core inflation (excluding volatile components such as food and energy), measured through the Core PCE, rebounded slightly to 2.8% from 2.6%, while the estimate for 2025 rose slightly to 2.3%.

During his press conference, Jerome Powell commented that monetary policy is well-positioned and that if the economy remains strong and inflation persists at elevated levels, the FED would be prepared to maintain rates within the current range. He also emphasized that the FED’s estimates are not necessarily indicative of the decisions the Committee might take. Finally, Powell stressed the importance of seeing consistent improvement in inflation before applying a rate cut. He reminded that the baselines for inflation on an annual basis for the remaining months of the year will not be easy to surpass, which could result in continued elevated readings.

FED Indicators Update (June vs. March)

Source: Federal Reserve

With an advance of approximately 95% of the votes counted, Claudia Sheinbaum Pardo, representing the ruling coalition (Morena, PT and Green Party), will be the first woman president in 200 years of independent life in the Mexican Republic. In this sense, it is noteworthy that her victory was overwhelming having counted ~59% of the votes, which represented a difference of more than 30 points against the opposition candidate. With this, Claudia Sheinbaum registered more votes than López Obrador obtained in the 2018 elections and becomes the president with the most votes in Mexico’s history. Claudia Sheinbaum was previously head of government of Mexico City (2018-2023), head of the Tlalpan mayor’s office (2015-2017) and secretary of the Environment (2000-2006). On the other hand, citizen participation ranged between 60% and 61.5%, lower than that seen in 2018 which was 63.4% and the average of the last five elections which stood at approximately 65%.

In this context, the ruling coalition won 7 of the candidacies that were at stake, with an outstanding victory in Mexico City, as well as the victory in the state of Yucatan, which was governed by the opposition for many years. Regarding the new conformation of the Congress, it is expected that the ruling coalition will reach the constitutional majority in the Congress of Deputies and by a very small margin will obtain a qualified majority in the Senate. Therefore, the Morena party consolidates for the third consecutive time (2018, 2021 and 2024) as the first force in the Congress of Deputies and for the second time in the Senate of the Republic (2018 and 2024). The new Legislature (LXVI) of the Congress will begin its functions on September 1, 2024, where President López Obrador’s mandate will come to an end on the 30th of that same month. That said, the new legislature will coincide with the current president for 30 days. The inauguration of the new president will be on October 1.

Finally, some of the challenges that this new government will face during the first half of its six-year term will be related to reducing the budget deficit (around 6%, the highest in 25 years), the elections in the United States, the review of the T-MEC, capitalizing on the opportunities linked to nearshoring, avoiding institutional weakening and reducing insecurity rates in the country.

Recomposition of states governed by the ruling coalition (Morena and allies) vs. opposition bloc (PRI – PAN) and Movimiento Ciudadano.

Source: Holland & Knight with information from INE

The importance of the consumer within the U.S. economy cannot be underestimated, being the main engine of growth, accounting for ~70% of its Gross Domestic Product (GDP). For this reason, we present some perspectives because, so far, the consumer has shown resilience, supported by a strong labor market, excess savings in the wake of the pandemic, and wage increases. However, some deterioration has begun to show, which could imply some challenges in the short-term. Important points:

• Deteriorating consumer sentiment and record indebtedness: Consumer confidence has now fallen for three consecutive months in the face of high interest rates and persistent inflation. On the other hand, household debt reached a record US$17.7 trillion in the first quarter of 2024, with default rates rising, especially on credit card debt. Despite this, debt servicing costs remain manageable because 75% of households have a mortgage with a 4% rate, compared to the current rate of around 7%.
• Caution in consumption patterns, with healthy balance sheets: Consumers, especially in the lower income segments, are becoming more cautious with their spending. This trend was evident in recent retail sales reports, as well as in the recent quarterly reporting season, where companies such as Amazon and Pepsi emphasized a preference for more economical options. For their part, household balance sheets prevail strong, supported by a rising stock market, rising home values and higher interest rates on savings accounts, allowing families’ net worth to increase. The mix of these elements has been a key component in the resilience of consumer spending.
• Real wage growth: The combination of healthy labor markets and the disinflationary process have contributed to growth in real incomes over the past 12 months. While there are some concerns that this favorable trend may stall as the labor market cools and inflation remains stable, there is reason to believe that this dynamic in wages will continue.
• Increased signs of defaults: In this regard, the FED in New York cited that nearly 1 in 5 borrowers are now “maxed out” on their credit cards and that the percentage of balances moving into serious default (i.e., 90 days past due) has risen to the highest level since 2011. While this is usually a worrisome sign for an economy driven by consumer spending, total outstanding debt at some point in default (~3.3%) is still quite low.

Under this context, economic growth estimates for this year remain around ~2.3%, supported by modest employment generation, the ability to continue witnessing increases in real wages and household net worth at record levels (US$156 trillion at the end of 4Q23).

Household debt service payment as a percentage of disposable income

Source: Raymond James 

Practically in the home stretch, with just over 90% of the S&P 500 sample having reported their numbers, below, we share some relevant takeaways and perspectives from the first quarter earnings season of the year.

• Reasonable earnings growth: Despite general economic concerns amid high interest rates and a pickup in inflation, S&P 500 earnings beat expectations after the index reported 6% annual growth in earnings per share (EPS), exceeding the anticipated growth of 3%.

• Sector performance: The Communication Services (+38%), Utilities (+30%), Information Technology (+24%) and Consumer Discretionary (+24%) sectors posted the strongest annual earnings growth. While Brent crude oil prices in the 1Q24 prevailed unchanged versus the prior year, natural gas prices collapsed 24% and aligned more closely with the 26% and 21% annual decline in earnings in the Energy and Materials sectors, respectively. Finally, EPS in the Healthcare sector also declined 26%, albeit primarily due to Bristol-Myers Squibb’s (BMY) one-time expenses related to its acquisition of the Karuna company.

• Mixed consumer signals: Companies in the Consumer Discretionary and Consumer Staples sectors provided mixed outlooks, with some noting a slowdown in consumer demand while others reported strength. For example, McDonald’s outlined a more selective spending, while American Express noted an 8% annual increase in customer spending.

• Increased investment in Artificial Intelligence (AI) continues: Companies such as Amazon and Meta announced substantial investments (CAPEX) to improve their AI capabilities. In this context, this focus on AI is expected to drive future productivity gains and revenue expansion.

• Performance and expectations of the “Magnificent 7”: This block of companies, comprising AAPL, AMZN, GOOGL, META, MSFT, NVDA and TSLA, reported combined earnings growth of 48% YoY. This robust growth was driven primarily by a substantial increase in their sales and a significant expansion of their profitability margins. For example, META and GOOGL led the group with a sales growth of 27% and 15%, respectively. In contrast, AAPL and TSLA experienced sales declines of 4% and 9%, respectively. The outlook for these companies remains strong, especially for those investing substantially in AI. Although their numbers were positive overall, there is significant dispersion among their financial results within the group.

• Market forecasts: Based on the above, the consensus estimates that the EPS of the S&P 500 for the whole of 2024 would reach US$244, which would imply an annual growth of 9%. By 2025, the EPS would reach US$277, which would represent an annual increase of 13%.

S&P 500 sales, margins and earnings growth in the 1Q 2024:

Source: U.S. Bureau of Labor Statistics

The Consumer Price Index (CPI) posted a modest 0.3% increase in April 2024, following a slightly higher 0.4% increase in March, beating expectations that also anticipated a 0.4% increase. With this, the CPI climbed 3.4% annually from 3.5% in the previous month. On the other hand, core inflation excluding food and energy (Core CPI) continued its steady increase of 0.3% in April, similar to the previous three months and in line with expectations. However, in its annual variation, it observed a deceleration to 3.6% from 3.8% and resulted in the lowest since April 2021.

Below, we share the performance of the key components:  

• Energy: The energy index rose 1.1% in the month, maintaining the same increase as in March. This increase was significantly influenced by a 2.8% increase in gasoline prices. Annually, the energy index increased 2.6% with a 1.2% increase in gasoline prices.
• Food: Food indexes showed little change overall. The food at home index decreased slightly by 0.2%, while food away from home increased by 0.3%. With these data, the overall food index rose 2.2% over the past twelve months, with a significant 4.1% increase in food consumed away from home.
• Housing Costs: These continue to be an important driver of the index, after rising 0.4% in the month. Over the last twelve months, the lodging index increased 5.5%, indicating that housing costs maintain persistent upward pressure. Importantly, this category contributed substantially to the 3.6% annual increase in the core index.

Finally, the transportation and medical care categories recorded notable increases. In this sense, transportation services increased by 11.2% in the last year (0.9% in the month), while medical services saw a more moderate increase of 2.7% (0.4% in the month).

In this context, it can be concluded that the April report, to some extent, offers positive news that could provide some relief to the FED. However, the reality is that sustained inflationary pressures continue to be seen in terms of energy and housing costs. Therefore, markets may continue to navigate a higher interest rate environment for some time to come, at least until it becomes clearer that inflation is moving more strongly toward the FED’s 2% long-term target. Given this data, as well as the latest employment figures, the consensus is for the FED to leave the reference rate unchanged at 5.25 – 5.50% for the June 12 meeting. 

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

Monthly change (%) of CPI

Source: U.S. Bureau of Labor Statistics

Key employment figures for the month of April were recently released and showed a weaker than expected performance and a marked slowdown compared to previous months. In this sense, nonfarm payrolls posted 175,000 jobs last month, down from the average of 269,000 jobs during the previous three months, and implied the lowest gain since October of last year.

Breaking down the data, the public sector was the main driver of this decline in reported job growth for April, as only 8,000 government jobs were added, compared to an average pace of 60,000 over the previous six months. For its part, the private sector continued to add jobs at a solid pace in April (+153,000), with the health care and social assistance sector accounting for more than half of these jobs (87,000).

As another sign of subdued labor demand, it is noted that the average workweek fell to 34.3 hours, and the unemployment rate rebounded slightly from 3.8% in March to 3.9% last month. Finally, average hourly wages increased by only 0.2% in the month, and with downward revisions from the previous month. Against this backdrop, annual wage growth declined to 3.9% from last year’s average of 4.4%. While all of these figures were less robust than in previous months, overall, they still reflect a healthy labor market environment.

That said, April’s employment figures, together with the first estimate of the 1Q24 GDP, which experienced an annualized growth of 1.6%, down from the 2.4% expected and 3.4% in the 4Q23, would be reinforcing the idea that the economy is heading towards a “soft landing”, the central scenario proposed for this year.

Regarding the potential implications of monetary policy, from the possible implications of monetary policy, it will be important to observe whether the next employment reports maintain this cooling trend. However, we do not rule out that FED officials have interpreted these figures positively, seeing them as a welcome sign that the labor market continues to reach a better balance and that monetary policy is tight enough. Next week will be crucial, as inflation for the month of April will be released. A slight expected decline to 3.7% annually  (excluding the volatile energy and food components) is expected. So far, consensus broadly indicates that the federal funds rate will remain in the 5.25% to 5.50% range for the next meeting on June 12.  

Nonfarm payrolls evolution 

• Monthly change, figures in thousands. 

Source: JP Morgan

The Federal Reserve (Fed) made the unanimous and widely expected decision to once again keep the target range for the federal funds rate unchanged at 5.25% – 5.50%, its highest level in the past 22 years. Since July of last year, the benchmark rate has remained unchanged. This decision comes in a context of accelerating inflation during the current year, placing it at 3.5% annually in March (3.8% annually excluding components with higher volatility such as food and energy), up from 3.2% in February.

On the other hand, the statement described that the latest employment indicators have shown solid performance, while inflation has decreased over the past year, although it remains elevated. In that sense, it was highlighted that, in recent months, there has been a lack of additional progress toward the Committee’s 2% inflation target. Therefore, it was reiterated that it is not expected to be appropriate to reduce the target range of the benchmark rate until there is greater confidence that inflation is moving sustainably toward its goal, and it will remain highly attentive to inflation risks. Despite the above, the Committee considers that the risks to achieving its employment and inflation objectives have moved towards a better balance in the last year.

Finally, an adjustment to its program of reducing holdings of Treasury bonds, agency debt, and agency mortgage-backed securities known as “Quantitative Tightening” was announced. Starting on June 1, only US$25 billion in Treasury bonds will be allowed to run off each month, compared to the current US$60 billion. Mortgage-backed securities will continue to run off by up to US$35 billion monthly.

During his press conference, Jerome Powell primarily highlighted that he considers it unlikely that the next interest rate move will be an increase, emphasizing that for now, that scenario appears improbable.

Evolution in the number of expected rate cuts for the federal funds rate

Source: Raymond James