A delicate balancing act
586 Monday, 21 July 2025 12:38
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A supportive preliminary earnings picture. The earnings season is about to get into full swing, and preliminary insights are reassuring. With about 10% of the companies in the S&P 500 and STOXX Europe 600 having reported, the (very) first take is positive compared to expectations, which were watered down in recent months. In the US, sectors such as financials and consumer discretionary are beating consensus expectations by a wide margin. In parallel, the “beat ratio” for industrials and consumer staples stands in the mid-single digits. In Europe, a similar pattern is taking shape. Earnings from the consumer discretionary, technology, and communications sectors to date have been 10-12% above expectations, while industrials and consumer staples are lagging. For the remaining sectors, the number of companies having reported is too low to make any observation at this stage.
Macro releases are also soothing investor concerns. The overall picture suggested by corporate earnings is consistent with the US macro releases for Q2, which are also now being made available. The rebound in June retail sales (after worrying figures in April and May) and the softening of initial jobless claims both corroborate the assumption that investors and businesses are regaining confidence after the late-Q1 trade shock. We show in the report that the impact of trade tariffs on inflation, consumer spending, and job creation is so far proving limited and is being counterbalanced by other factors. In retrospect, markets are receiving confirmation that the Q2 market rebound did not arise out of thin air. The valuation of the big blue chips (Mag 7), and mechanically of major equity benchmarks, will likely be compressed by upward revisions to corporate earnings, but will remain rich.
How to trade it? Historically, equity markets tend to underperform in August and September, both in the US and in Europe. The so-called summer curse refers to market episodes such as the Russian crisis / LTCM implosion in 1998; the mortgage securities and money market freeze in 2007; the Fannie Mae “jolt” in 2008; the US sovereign downgrade in 2011; the Fed taper tantrum in 2013; and the Renminbi devaluation in 2015… On such occasions, shocks occurring in August have been amplified by weak liquidity conditions and had significant contagion effects globally. At present, visibility remains low on trade deals, and the 1 August deadline (12 August for China) could cause nervousness if progress on trade deals remains lacklustre. The US CPI data for June showed the first impacts from rising tariffs, and we believe the topic of trade remains an important factor to consider. The higher the equity markets, the higher the chance of renewed volatility if Trump proceeds too aggressively.
- The global economy's resilience in the face of recent uncertainty shocks leads us to be Overweight equities, but not very aggressively given seasonal factors and important milestones in the coming weeks.
- In relative terms, fiscal discipline concerns lead us to be Underweight government bonds, and Overweight credit despite tight spreads versus sovereigns.
- Selectively positive on the consumer theme in Europe. Our Overweight stance on travel & leisure and retail in European equities remains unchanged. The former benefits from cyclical factors (lower energy costs) and structural trends (passenger demand at record highs). Meanwhile, the retail sector is domestic, i.e. less exposed to trade wars than luxury, while the euro strength/US dollar weakness support lower sourcing costs.
- USD steepeners and Fed independence: Renewed pressure on the Fed chairman was immediately contested by markets last week, forcing Trump to step back. Despite all the buzz, FOMC members are increasingly open to fresh rate cuts in H2. Trump will likely also nominate a rather dovish governor in the coming months, to replace Powell who leaves in May 2026. We just hope the next chairman will not be a controversial figure, causing market frictions like Kennedy Jr. for pharma. Christopher Waller would be the less disruptive pick for the job. To hedge against political interference, we like USD steepeners. Coupled with the Fed’s renewed dovishness, long-term uncertainties over its readiness to fight inflation would cause a faster steepening of the yield curve.
- China and the trade détente with the US. As part of our efforts to find avenues of diversification, EM Asia looks likely to fare better than Japan in trade negotiations with the US. China is reaching compromises with Trump (US semiconductor export constraints were sweetened last week), as its rather weak economy reduces its leverage. Trump also needs China’s rare earths and has reportedly softened the tone on China, as he wants to secure a summit with Xi Jinping and a longer-term trade agreement. According to Bloomberg, US officials are preparing to delay a 12 August deadline, when US tariffs on China are set to snap back to 145% after the expiration of a 90-day truce.
Week ahead: Preliminary PMIs in major economies, durable goods orders in the US, ECB meeting (see preview in the report). On the earnings front, 110 companies in the S&P 500 will report earnings, of which several industrial and defence names. In Europe, 91 companies in the STOXX Europe 600 will report, of which banks, energy, and luxury companies.
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