In more recent time periods, macro-related news including GDP growth and PMI data have driven market sentiment and accordingly returns. At the mid-way point of the year, however, Q2 earnings have taken center stage. For this reason, we opted to substitute our weekly macro review with an update on earnings from both the broader market and our portfolio companies.
If we were to just focus on the US and specifically the S&P 500, 229 companies have reported Q2 earnings through 7/24. Of the 229, 155 companies beat EPS consensus expectations, 41 missed, and 33 met. At 68%, the number of “beats” is high relative to recent periods – although we are only at the halfway point early results are encouraging. Also encouraging, the level of operating margins for the index is on pace to eclipse 10% in Q2, a new record for the S&P 500. Despite skeptics repeatedly calling for operating margins to revert to the mean, companies have continued to depress costs and drive through an increasing share of revenue to the bottom line. In many situations, companies are still cutting costs six years post the Financial Crisis. Case in point, through the first six months of the year, IBM reduced operating costs by $500mm year over year and they are on pace to cut even more. Focusing on the bottom-line, one more lever that continues to be pressed is share buybacks. A statistic recently shared indicates that 20% of the companies that have reported Q2 results have reduced their year over year share count by 4%.
When the above data is combined with recent strength in leading economic indicators, it suggests that the engine of US corporations is hitting on all cylinders and it better be. Over the past 18 months, US investor mindset has transitioned from the “glass being half empty” to the “glass being half full” and accordingly multiples and expectations are higher than in recent years. We would argue that if the second quarter was simply “in-line” with expectations and not “above”, markets could be in for a difficult time through the second half of the year. At this juncture, we ourselves aren’t feeling complacent but admit that the backdrop today is supportive of equity prices. The largest risk remains the exit of fed policy later this year and in 2015 – accordingly we remain moderate in overall risk levels despite the above enthusiasm.