When will UK inflation fall, and what to expect from earnings?

Global stocks ended last week in the green, and they have had a good start on Monday. US stocks are higher on the day, even though they had a wobble when Chinese GDP data came in weaker than expected. Chinese GDP rose 0.8% on the quarter, weaker than thee 2.2% quarterly rate in Q1, while growth was 6.3% on an annualised basis, weaker than the 7.3% expected.  Retail sales for June were 3.1% higher than a year earlier, significantly lower than the 12.7% annualised rate reached in May. This data confirms what many had assumed, that China’s post-Covid boom has already run out of steam. Q1 saw pent up demand boost growth, while a mere 12 weeks later that effect has moderated sharply. The reaction was felt keenly in Europe, where European indices were a sea of red. The oil price dipped by 1.46% at the start of the week, while the Cac 40 in France was the weakest performer in Europe, down 1.12%, dragged lower by the luxury sector, Hermes was down 4.21%, while LVMH was down more than 3.5%. If China isn’t leading global growth higher in 2023, then all eyes will focus on the US.

Earnings season: Netflix could break a record

To answer this question, it helps to go back to stock investing 101, where something I read this week reminded me that equities tend to do better after a period of underperformance, and they tend to do worse after a period of above average returns. Since the S&P 500 is up 17.37% so far this year, does this mean that the US blue-chip index is poised for a fall? That may depend on two things: 1, what the Fed does next and 2, Q2 earnings season which kicked off last week. After a much better inflation print for June, expectations are growing for a soft economic landing and the peak for US interest rates to possibly come next week. Thus, the former point appears to be positive for US stocks in the medium term. This leaves earnings season. There were strong results from the likes of JP Morgan and Wells Fargo on Friday. This week we see Netflix and Tesla report Q2 earnings. Netflix is expected to post stellar results, with a record number of people expected to be paying to watch the streaming giant after it clamped down on password sharing and released a cheaper tier of membership that comes with adverts. If analysts are correct, then Netflix may have added 1.8 million new subscribers last quarter, bringing its total paying audience to 234.5mn. Revenues are expected to have risen by 4% on the quarter, however net income is expected to come in 11% lower than a year ago, due to the changes that it has enacted on its platform. These are important results, especially since the Netflix share price is up more than 50% YTD, so the record subscriber numbers are needed to justify this increase. Momentum is on the upside for Netflix, and bar any nasty surprises, we could see this stock move higher on the back of strong results, even if gains moderate somewhat from the first half of the year.

Why earnings could surprise on the upside

Overall, the market is expecting a lacklustre earnings season. According to FactSet, the data analytics company, analysts are expecting a third straight quarter of a decline in earnings for the S&P 500. Analysts expect a YoY earnings decline of 7.1% in Q2, which would mark the largest decline in earnings since Q2 2020 – the peak of the global pandemic. However, analysts tend to be a pessimistic bunch, considering the economy has held up well in the first half of the year, could S&P 500 companies beat estimates? At this very early stage, Q2 earnings season is off to a strong start, both the number of positive earnings surprises and the magnitude of the surprise is above its 10-year average. Of the 6% of companies that have reported earnings in the S&P 500, 80% have beaten actual EPS estimates. In aggregate, companies are reporting earnings that are 8.8% above estimates, and the financial sector has had the largest rate of positive earnings surprises. This is hardly surprising, since financials are the first companies in the S&P 500 to report earnings, added to this 6% of the S&P 500 is a small sample size to try and extrapolate themes regarding Q2 earnings season. However, there is a kernel of optimism that the US stock market could defy the gloomy expectations for the duration of earnings season, which may translate to another leg higher for stocks as we move through the third quarter of 2023. We will be watching how individual stocks react to earnings beats to see if the momentum in the first half of the year can be maintained as we move into the second half.

Stocks and the dollar, what could come next for the beleaguered greenback

Stronger stocks could mean a weaker dollar. The dollar index fell some 2.34% last week, could there be further weakness? We think it will depend on whether the Federal Reserve signals if it is done with raising interest rates when it meets next week. If yes, then it is hard to see how the dollar can recover in the short to medium term. However, there are a couple of channels that could trigger a dollar recovery: 1, weaker earnings than expected, which we think is unlikely, and 2, a shift in the European and UK economic data that could weigh on the pound and the euro, both of which are riding high against the dollar. Focusing on the UK, inflation data will be key to watch this week. The market expects the annual rate to fall to 8.2% from 8.7%. This would mark one of the widest Transatlantic inflation gaps since the 1970s, after US headline inflation fell to 3% last month. This gap is fuelling GBP/USD strength.  If inflation does come in at 8.2%, this is higher than the BOE’s forecast for the UK’s inflation rate in June of 7.9%. It will also further highlight how the UK is a global inflation outlier, especially since core inflation is expected to remain unchanged at 7.1%, suggesting that the BOE still has much work to do to tighten monetary policy and bring down price pressures. If inflation remains elevated in the UK relative to its global peers, then we should expect more pound strength in the short term or until economic growth shows more severe signs of strain.

When will UK price pressures start to fall?

The UK’s consumer-based economy could struggle under the burden of higher rates, if inflation does not fall as fast as expected in the coming months, and we don’t reach the BOE’s terminal rate soon. Of course, it is worth pointing out that UK producer price growth for May was negative, so there is deflation at the start of the inflation pipeline, however, producer prices are not impacted by profit-led inflation, or greedflation. Thus, if UK stocks experience a strong Q2 earnings season, we expect to see accusations of greedy corporate behaviour. However, eventually we expect to see competition for sales from a stressed consumer along with competition for labour as being the key drivers to 1, reducing inflation in the UK, especially service price inflation and 2, squeezing corporate profit margins. This may not happen in Q2, but it could be on the cards for later this year.