- While 3Q earnings should show some improvement, we expect that operating earnings growth will be negative on a year-over-year basis.
- The earnings story continues to be dominated by headwinds from dollarstrength and lower energy prices, but we are seeing signs that these obstacles are nearly behind us
- 2017 earnings estimates remain too high, and it will be important that any rerating is gradual in order to avoid a sharp sell-off in equities next year
Defensive sectors continue to look expensive and could be at risk as interest rates rise going forward, suggesting there is more opportunity in the cyclical parts of the stock market
The good and bad of 3Q earningsThe U.S. profit recession has been underway for seven consecutive quarters, and while we do not expect earnings growth to turn positive in 3Q, it appears that we are closer to the end of this story than we are to the beginning. However, every silver lining has a touch of grey. The good news: 3Q earnings should show a trend of continued improvement, and earnings growth should gradually turn positive over the next couple of quarters. The bad news: headwinds from low energy prices and a stronger dollar are not yet behind us, and expectations for earnings growth in 2017 look overly optimistic.
Soft growth and politicsEconomic growth continues to look mixed. The soft-patch seen in the U.S. toward the end of the summer seems to be fading, with manufacturing showing signs of stability and a September rebound in the service sector leading recession fears to the sidelines. In Europe, the expansion remains slow but steady - credit growth is sufficient to support moderate economic growth, but the broader environment cannot be described as robust. Meanwhile, emerging markets are experiencing reflation on the back of more stable currency and commodity prices, leading the gap which emerged between developed and emerging market PMIs to narrow (Exhibit 1).
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