The Strategist

Three surprises in the Q3 reporting season

10/19/2017 - 08:11

The reporting season for the third quarter is now officially open - J.P. Morgan Chase and Citigroup have already revealed their results. Investors and analysts will closely monitor results of companies to understand whether they justify the recent stock market records. Corporations may refer to a series of events in the past three months, including hurricanes that devastated certain regions of Texas, Florida, and caused significant damage to Puerto Rico and the Caribbean. Here are three main factors that can have a significant impact on the results of companies in the third quarter.

Gone with the hurricane

According to the National Hurricane Center in September, the number of natural disasters in the US turned out to be the highest in the history of observations, says MarketWatch. The cataclysms could affect results of many companies from different sectors. Consequences of hurricanes Harvey, Irma and Maria have already affected the national statistics - in September the number of jobs decreased by 33 thousand for the first time in seven years.

Air carriers, insurance, retail and energy companies reduced forecasts, citing the harmful effects of natural disasters. According to forecasts, the sector's profit will decrease by 8.6%. The main impact will fall on insurance companies: it is expected that their combined revenues will decrease by 45.1% compared to the same period last year.

Pharmaceuticals and medical companies that use Puerto Rico as a production base are likely to suffer, too. The US Food and Drug Administration have warned of a shortage of "vital drugs" because of the damage caused to the island by hurricanes.

Two drug manufacturers have already told about the impact of tropical storms on activities in Puerto Rico. Amgen said that there will be no supply interruptions, as the company has sufficient reserves to meet the needs of patients. The island hosts Amgen’s production facilities, which in total employs more than 2 thousand people. In turn, AbbVie stated that its production facilities in Puerto Rico "have not suffered and are operating at full strength" thanks to an independent source of electricity. The corporation assures that customers will not suffer in any way (1,100 people work at AbbVie's facilities in Puerto Rico).

It is expected that some companies will even benefit from efforts to restore buildings and infrastructure as soon as insurance companies begin paying. In September, demand for cars jumped: consumers rushed to replace cars destroyed by storms. The trend will gain momentum as funds from insurance companies are coming. In addition, manufacturers of building materials, furniture and accessories can count on increasing demand.

Politics of Donald Trump

The presidential administration’s inability to push most of the reforms through Congress can once again affect results of the Q3. In the second quarter, the failure of tax reform, health care reform and trade policy made it difficult for corporations to make investment decisions (which affected their results).

In the second quarter, reserves of companies increased by $ 60 billion, compared to a deficit of 22 billion in the previous 12 months. JP Morgan's strategist Dubravko Lakos-Bujas believes that political uncertainty in the country is partly to blame for the suppressed investment activity. He also noted the high cost of assets and the growing cost of capital. CFOs interviewed by Deloitte in the CFO Signals review called political instability and geopolitical risks the main reasons for concern. According to their estimates, impact of these factors increased in the third quarter.

Political and geopolitical tensions also grew up compared to the second quarter. The verbal skirmish between Trump and Kim Jong-un was exacerbated, separatist sentiments in Catalonia led to a split in Spain and frightened EU leaders.

Additional uncertainty is created by Trump's statements about withdrawing from the North American Free Trade Agreement (NAFTA) and making isolated deals with Canada and Mexico. Nervousness is facilitated by the American president’s endless Twitter attacks, criticism of members of his own administration and party, attacks at the National Football League and the media.

Weak dollar makes sales outside the US attractive

S&P 500 companies can no longer blame the dollar for falling sales and profits. In the past, tightening monetary policy and increasing economic growth in the US led to a rise in the price of the dollar and served as an excuse for multinational corporations when their results declined or turned out to be worse than forecasts.

Companies are using phrases such as "in constant dollars" or "in local currency" to provide investors with an accurate picture of the results without the negative impact of exchange rates. However, in the third quarter, the average closing price of the US dollar index, which measures the exchange rate of the US dollar against the basket of world currencies, was 93,439, which is 2.4% lower than in the same period last year. Of 63 trading sessions of the third quarter, 57 of them closed the dollar index below the average of last year.

The weakening of the dollar helps multinational corporations by reducing the cost of exports and increasing the attractiveness of American goods abroad. In addition, it increases the nominal value of revenue and profits received from abroad. Therefore, do not be surprised if the companies decide not to include data "in constant currency" in their reports - the comparison will not be in their favor.

Although the weakening of the dollar can help Wall Street and large multinational corporations, it is not very profitable for smaller players and manufacturing companies, as effective cost of foreign goods and raw materials is growing. Since the inauguration of Donald Trump and until the end of the third quarter, the dollar index has decreased by 7.7%. During the same period, the S&P 500 index grew by 11%, the index of small cap companies S&P Small Cap 600 added 9.2%.

The vulnerable dollar reflects acceleration of economic growth outside the country and its slowdown within the United States. It promotes superiority of large American corporations with a significant share of sales abroad over competitors with less penetration of foreign markets.

In the economic forecast published in October, the International Monetary Fund noted global economic progress: "Growth in the euro area, Japan, Russia, developing countries in Asia and Europe more than compensates for the decline in economic activity in the US and Britain." According to FacSet forecasts, in the third quarter, profits of companies from the S&P 500, oriented mainly to the domestic market (the share of overseas sales is less than 50%), will decrease by 0.1%. Profits of corporations targeting foreign markets (more than 50% of sales abroad) will grow by 7.9%. Similarly, the revenue of companies oriented to the US will increase by 3.8%, oriented to foreign countries - by 7.7%.