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Beyond the Headlines

In this week’s economic update, we kick off with the earnings season in the US exploring the data which has rolled in thus far for the first quarter of 2019 and the expectations going forward. We then head over to India where the largest election in the history of the world is underway. As expected, rivalry is fierce but it is the policies which have caught our eye.

US Earnings – The Results Roll in

Quarterly earnings season is upon us once again! The season is dominated by US companies reporting. It is monitored closely by market participants for updates on recent trading and profits earned. Companies also provide forward guidance, allowing investors to set future expectations. This in turn helps analysts determine whether the valuations placed on businesses are justified.

2018 was an extraordinary year for US corporate earnings. They were buoyed by;

• loose monetary policy
• synchronised, above trend, global growth
• sizeable US fiscal stimulus, including corporate tax cuts

With earnings soaring last year a high bar has been established for profits to climb over in 2019. To make matters more challenging, global growth has moderated, falling closer to trend levels.

There are various reasons for the current slowdown, not least a change to monetary conditions. The Federal Reserve has raised interest rates 9 times since 2015. Trump’s tax cuts have also faded from memories. As a one-off boost they were great, but in the meantime, US government shutdowns and adverse weather have disrupted economic activity.

Given the shakier backdrop it is not altogether surprising that business management teams have been forewarning analysts to lower their earnings forecasts. Current forecasts for the first three months of 2019 show that analysts are expecting a quarter on quarter fall of 4.2% in earnings across the S&P 500 index.

Results are now beginning to appear. It is early days, with just 24 companies out of the 500 reporting. So far 20 have reported an earnings surprise, i.e. published results that have exceed analyst expectations. Unfortunately, the small sample size means we are unable to draw meaningful conclusions at this stage.

Companies reporting cover a large swathe of sectors, some economically sensitive and some less so. In the Energy, Materials and Technology sectors companies reporting have issued disappointing forward guidance. Slowing global growth, ongoing tension in US-China trade relations and a lacklustre oil price (now staging a resurgence) have been unhelpful to many businesses in these sectors. On the other hand, companies in the Utilities, Health Care and Services sectors are expected to show greater resilience. These companies are less sensitive to cyclical economic growth.

But what are analyst expecting as the year unfolds? In the graph below, we can see that company profits, represented by earnings per share (EPS), are expected to stabilise in quarter 2, before growing again in the second half of 2019.

S&P Historic and Forecast EPS. Source: Bloomberg, April 2019

The improvement forecast for the second half of the year is being constantly updated. If profit forecasts shown in our chart prove to be correct, it will signify an end to the slowdown in global growth. It will also represent an elongation of the current growth cycle, underway since the dark days of the credit crisis. Fears raised last year pointing to a possible recession now seem more aligned with a soft patch in a longer series of positive numbers, and the trend is turning up.

India’s Ballot Bonanza

If you think preparing for EU elections is a headache spare a thought for India’s electoral commission. They must contend with the biggest election in the history of the world (by population). This week, 1 million polling stations will be set up for 7 stages of voting, catering for an estimated 900 million voters. A turn-out of between 65% and 70% of those eligible to vote is expected with the result being announced on the 23rd May.

The vote taking place will elect parliamentary members into the seats of the lower house (Lok Sabha). A majority in the Lok Sabha gives control of the government. Currently, the majority is held by the Hindu nationalist Bharatiya Janata Party (BJP), led by Prime Minister Narendra Modi. His party has been in power for the last 5 years.

In the upcoming elections competition is expected to be fierce. Insults will no doubt be traded. One thing is for sure, the opposition will be keen to draw attention to all failings of the existing government. In the opposition camp, Rahul Gandhi, the descendant of two former Prime Ministers, is his nearest rival. He is a fierce critic and a strong contender. Also, Congress is looking to build alliances to defeat Modi.

Modi was elected in 2014 to kickstart a stalling economy. High levels of inflation and weakening levels of international competitiveness were holding back progress. Stripping back the complexities around local government spending, regulation, tax structures (introduction of a simplified goods and services tax) and by encouraging foreign direct investment Modi has embraced free market forces.

Modi’s direct leadership style was demonstrated in 2016 when the BJP announced they would withdraw all high-value banknotes from circulation, removing 85% of cash notes, almost overnight to wash out any undeclared wealth and encourage the push towards electronic finance. The immediate effectiveness was not as expected with 99% of notes withdrawn being returned to the banks, suggesting these piles of cash were not under mattresses but embezzled in the financial system and all the unrest, pressure on rural business and humanity was brushed under the carpet building ammunition for his critics. The longer-term impact, however, is believed to have been more effective, contributing to an uptick in tax revenues of around 30% since 2016 through increased transparency, helping to identify tax evaders.

The impact on the economic landscape has been meaningful, not least to the competitiveness of business. In 2014 India was ranked 142 (out of 190) in the World Bank’s ‘ease of doing business’ survey. India is now ranked 77th, with a goal of being in the top 50 by 2020. Improvement’s across business have had a positive impact on the economy. Recently, we wrote about India’s improving growth trajectory and how it is set to outpace China. We show this again in the chart below.

Annual GDP Growth % – India and China Compared. Source Bloomberg, April 2019

Modi is keen to maintain growth at a fast clip. He also aims to enhance social security, job creation, and agricultural stability. The latter is where he has received most of the criticism. Consequently, he is now aiming to double the income of farmers by 2022. Although the agrarian economy tag placed against India is lessening, agriculture continues to be very important, particularly in rural India. To reach out to farmers Modi is proposing government subsidies and easier access to finance for capital investment. He is also introducing a pension scheme for small farmers. These policies play well with rural voters, but cynics worry about sustainability of such intervention. They also see a government keen to keep a check on inflation. This means keeping a lid on food prices which, ironically, pressures farm incomes.

As it stands the BJP looks likely to win, but they are not being complacent. They are putting everything into winning and as the incumbent government they can shape policy to win votes. From a global economic perspective, a Modi government will be welcomed. It offers stability and it represents a known entity. In a country where annually 10 million people will join the workforce a successful leader can make a significant difference.