TO MANY investors, the past three months in financial markets have felt particularly fraught.
Media commentators have turned from optimistic cheerleaders for a V-shaped recovery in both the economy and stock prices into seemingly inconsolable pessimists, greeting every political development and fluctuation in the economic data as confirmation that we are set inexorably on the path to ruin.
Objectively, it cannot be denied that there is some cause for concern.
There is clear evidence in American economic data that the eurozone debt issues have adversely affected corporate and consumer sentiment.
At the same time, measures to take the steam out of the Chinese growth engine appear to be bearing fruit at a possibly inconvenient time.
Judging from a stalled improvement in employment data in America, the increased uncertainty has at the very least delayed the transition from a cyclical rebound driven by inventory re-stocking to the more desirable sustainable growth pattern characterised by investment and employment growth.
However, the concern of those who fear a second dip into recession is that a reticence to invest, if extended to the end of the year, will then be compounded by increased fiscal drag manifest.
In Europe, this will come directly through austerity Budgets, while in the US it will be through the natural expiry of tax breaks originally instituted under the Bush presidency.
The hope of those who expect a more benign outcome is that the recovery in corporate profits has gained sufficient momentum to overwhelm these new uncertainties.
Specifically, in the context of “no reward” for sitting on cash, the pressure will be intense for any liquidity “build- up” on corporate balance sheets to be deployed into productive investment – such as machinery or even the acquisition of competitors.
Understanding these possible outcomes, the half-year corporate earnings reporting season that is now upon us is more important than usual.
America is particularly prompt in delivering its results, and already global blue-chip companies Intel, JP Morgan and General Electric have reported solid numbers.
Although the reception to these results has not been warm enough to move markets upwards, the broad message is encouraging.
Should the balance of results over the coming three weeks match up to the vanguard, forecasts of 50% year- over-year earnings growth for corporate America will be exceeded.
Those inclined to look at the glass as half empty will rightly point out that such rapid growth is largely a function of the depressed base against which this year is being compared. Last year’s second quarter was a very difficult time.
The evidence backs this up, since on a quarter-over-quarter basis there is likely to be very little growth.
However, this does not invalidate the optimistic position, since margins and free cash generation are expected to be at very high levels – so that the chief financial officers’ headache of finding a home for low-return cash piles will be increasing, even if not at an accelerating rate.
Franklin D Roosevelt famously said: “We have nothing to fear but fear itself”.
For corporations, the antidote to fear is profits. A good half-year earnings season should steady investors’ nerves, too.
