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How To Interpret This Season's Earnings Reports

When, after today’s market close, Alcoa (AA) reports their earnings and revenues for the second quarter of 2016 it will, for most people, signify the start of Q2 earnings season. In the modern economy, companies representative of the “new economy” such as the retail banks JP Morgan (JPM), Citibank (C) and Wells Fargo (WFC) who will report later this week, are in many ways of more significance than a metals company, but tradition holds that AA’s release marks the season’s beginning, so it makes for a good day to talk about earnings.

In general, the performance of Alcoa and other metal, minerals, and manufacturing companies this quarter will matter, but in terms of indicators of the economic future, they will take a backseat to other things. If you have been following the U.S. presidential campaign to this point, you will be aware that those industries are in decline.

Whether that decline is reversible by policy is debatable, as, I suppose, is the more fundamental question of the role of free trade in the problem. Even trade’s overall benefits seem to be being questioned by some, but, whatever the politics, traditional industries just don’t carry as much clout as they used to.

From a predictive perspective, industries that more directly reflect the mood of the U.S. consumer are more useful this quarter than materials and manufacturing companies with huge international exposure. With the Brexit and other issues in Europe and with Japan’s stubborn deflation, international weakness can be taken as a given.

It looks as if the U.S., still in many ways the best of a bad bunch of developed economies, will have to lead the way out, so the level of consumer-driven economic activity here will be paramount.

That is why the retail banks numbers will be important later this week. Their actual profitability is largely dependent upon performance in trading and investment banking, both of which are expected to weigh somewhat, but the more interesting metrics will be those, such as non-mortgage loan demand, that give indicators as to the level of optimism of consumers and small business owners.

Unfortunately, though, if estimates going in are to be believed, this quarter looks like being marked by some weakness in consumer-driven industries.

According to the table below, which was reproduced in this article from Zacks, very few sectors in the S&P 500 are expected to show positive growth from a year ago.

Even those that are and are consumer facing, such as autos and construction, do not paint a pretty picture. It looks as if, assuming these estimates are correct, the U.S. economy is stuck where it has been for a few years now. Consumers are spending on big ticket items that can be seen as an investment of sorts; a car to get to work, home improvements, or actually buying a house, but spending on tech and other discretionary goods remains muted.

It is not a good sign when utilities are expected to lead earnings growth, and once again it also looks as if some of the biggest earnings improvements will be coming from areas that are not responsive to consumers. Conglomerates, for example, are expected to show year on year improvement on the bottom line, but revenue declines.

That means that the difference comes from margin. Some of that margin improvement will be down to variable cost factors such as cheaper energy and a slightly weaker U.S. Dollar, but some will come from other areas, such as jobs losses and reduced capital expenditure. That kind of corporate profitability doesn’t exactly inspire confidence in future growth.

I shall, then, be keeping a close eye on earnings this week, but not in terms of what AA’s results tell us about the state of manufacturing. It is reasonable to assume that on a year on year basis that will be pretty poor.

In fact, according to Zacks’ estimates above, that could be said of the S&P 500 earnings overall, which are expected to show a 6.2 percent decline and a 3 percent drop in earnings ex-oil and energy. What will keep the market afloat despite that, though, is the prospect of better things to come, which can only be the case if there is evidence that the consumer is starting to loosen the purse strings. That, therefore, is what investors should be looking for.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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