Earnings and central banks dominate sentiment

As we start a new trading week, there are two main questions that the market wants answered. Firstly, how well did US tech stocks do in Q1, and does this justify their surge in valuations since the start of the year? Secondly, what will the Fed, the ECB and the Bank of England do when they meet next week, but before that will the BOJ abandon its policy of yield curve control at the inaugural meeting of their new President? The answer to these questions will determine price direction. It’s been a quiet few weeks for stocks, although things have become more interesting in the FX space, with EUR/USD breaking above $1.10 this week with $1.1050 resistance now in its sights. Thus, since weaker stocks, a weaker dollar and volatile bond markets don’t usually last for the long term, the market is searching for catalysts that could drive price action in the short term.

Can big tech’s earnings impress? 

Looking at earnings first, the start of Q1 earnings season for the US has outperformed relative to Q4 2022 and Q3 2022, however, the rate of positive earnings surprises and the magnitude of these positive surprises is lower than the 5-year average. On average, of the 18% of companies that are listed on the S&P 500 who have already released Q1 earnings, they are beating earnings expectations by a margin of 5.8%, according to FactSet the data analytics company. This is below the 5-year average of 8.4%, however, considering how negative the mood was leading up to this earnings season, it is a fairly good performance, all things considered. However, it is worth noting that the market is still expecting a large YoY earnings decline for Q1, and 60% of the S&P 500 is expected to report Q1 results in the next two weeks, so it is a little premature to infer any themes at this stage. Overall, while we note that the bar had been set low by equity analysts, and a positive surprise was thus to be expected, we would note that six of the 11 sectors in the S&P 500 have reported a YoY decline in earnings, led by healthcare, materials, IT, and communications. 

Why the stock market rally has slowed 

As we mention above, it is early days, and right now the market is wise to pause and scale back some of the earlier enthusiasm for stocks. Valuations are roughly in line with the 5-year average, at 18.2, the 5-year average is 18.5. However, this could be deemed expensive, considering the market is expecting the largest YoY earnings decline since Q2 2020, at the peak of the pandemic. Essentially, unless we see some of the largest companies in the US report results that are better than expected, then the overall YoY earnings figure for Q1 2023 may not improve, which could weigh on stocks. The risk is that it also drags down expectations for earnings in the second half of this year, which are currently expected to bounce back. Whether or not these expectations get scaled back, could be dependent on the outcome of the results from the likes of Coca Cola, McDonald’s, Microsoft, and Alphabet, who report in the next two days and they could give the market some much-needed direction. 

FTSE 100 vs Nasdaq and why UK tech is under pressure 

What a difference a few months make, after last year’s outperformance, the UK’S FTSE 100 is now lagging the Nasdaq. The US tech-heavy index has risen 20% this year and is technically in a bull market, even though interest rates have continued to climb, and the economic outlook remains uncertain. In contrast, the FTSE 100 is up a paltry 4.8%. What is also interesting, is that in the UK there has been a surge in profit warnings by technology businesses across all listed companies (not just FTSE 100 companies), which is down to delayed and cancelled contracts caused by economic uncertainty, according to analysts from EY. There have been 75 UK companies that issued profit warnings in Q1, and 16 of these are tech companies, which is three times as many compared with last year. Tech companies in the UK have also noted tougher fundraising conditions since the collapse of SVB bank last month, with the higher lending costs also weighing on the retail sector, although a strong consumer has helped to protect retail to some extent, it is behind the tech sector in terms of the number of warnings it has issued. 

Why tech earnings could direct stock markets for the long term 

This highlights the tricky junction investors find themselves in: on the one hand economic upgrades suggest that the UK will avoid the worst of a recession, on the other hand hopes that China’s reopening after Covid will lead to a surge in global growth is losing traction. For example, although China’s Q1 GDP beat forecasts, it is unlikely to lead to an industrial resurgence and instead was led by resilient consumer activity. Added to this, inflation remains stubbornly high, and we don’t know where central banks will go next; fears that central banks will make a policy mistake remains one of the key risks for 2023. What is interesting is that although earnings are not expected to improve until the second half of this year, inflows into equities remain high and stocks have, overall, performed well. Thus, investors may be happy to ride a wave of weak or so-so earnings in Q1 if company executives paint a positive picture for the future. If we see companies, especially big tech, miss earnings expectations and paint a dreary picture for the rest of the year, then we could see stocks, and especially the Nasdaq, struggle under the weight of a strong start to the year. 

The euro bounce back, and what next for the Yen 

Interest rate divergence is the key theme in the FX market right now. This is helping the euro to break above $1.10 vs the USD again, as the market expects the ECB to continue to hike interest rates long after the Fed starts to cut rates. This has also boosted the pound, which was the best performing of the major currencies in Q1, although we think the euro could steal the crown from GBP for Q2. USD/JPY is also in focus this week as we await the BOJ meeting. The dollar has risen nearly 3% vs. the JPY in a month, as expectations of a hawkish shift from the BOJ get scaled back. There is an expectation that the BOJ won’t change policy until June, even though inflation is at a 42-year high at 3.8%, largely because wage growth has been subdued. While policy may not be changed this week, will the tone of the BOJ press conference change? This is the big question for FX traders. If the Bank switches its focus from Covid support to inflation, then it could pave the way for tighter policy ahead. If that happens, then we would expect USD/JPY to come under pressure and some of that 3% gain in a month to get unwound. The BOJ meeting takes place on Thursday and Friday, if there is a whiff of hawkishness about it then the yen could be in demand across the G10 FX space.