S&P500 companies with high global exposure report lackluster Q1:2019 EPS growth due to trade concerns
Escalating trade uncertainty has coincided with a series of soft economic data in the US and China in the past week (retail sales, industrial production etc.), denting investors’ risk sentiment and threatening a previously envisaged growth stabilization in Q2:19. In the event, industrial production decelerated strongly in the US to 0.9% yoy in April from 5.4% yoy in September 2018 and remains weak across the board (China, EM Asia, Germany), likely reflecting subdued trade volumes. This has taken its toll on growth prospects and casts doubts on the H2:19 outlook, where most analysts, including ourselves, expect a gradual economic improvement.
As a result, government bond yields continued to decline (UST10Yr: -8 bps to 2.39%, a 2-month low | German Bund 10Yr: -6 bps to -0.10%, a 2½-year low) in the past week, as growth concerns and dovish expectations vis-à-vis central bank policies remain. Euro area periphery bond spreads were largely stable on a weekly basis, with yields slightly lower, as Italian officials suggested the government debt-to-GDP ratio is not likely to breach 140% (Italy’s 10Yr spread over Bund: +4 bps wow to 276 bps).
Global equities declined (MSCI ACWI: -0.8% wow | 11.3% ytd), albeit the decision on Friday (May 17th) by the US to delay for up to six months (up to mid-November) the imposition of increased tariffs on imports of cars, lifted sentiment late in the week. During that period, the US aims to negotiate a deal with the EU and Japan which will include a reduction in their autos exports to the US, for the increasing tariffs to be eventually avoided. Overall, US autos were supported by the news, albeit ending the week down due to a negative start. Regional performance in equities was mixed (SPX: -0.8% | SXXE: +1.4%), with US defensives over-performing cyclicals sectors.
Trade concerns have hit S&P500 companies with high global exposure (i.e., high international revenue shares, see table below), as their earnings under-performed in Q1:2019. Specifically, companies with more global exposure (<50% of sales in the US) reported a double-digit EPS decline in Q1 (-13% yoy), compared with more domestic-oriented peers (+6% yoy for companies with >50% of sales in the US).
At the same time, the stock price performance of high global revenue exposure corporations has been lackluster. Indeed, since the beginning of US-China trade brinkmanship (February 2018, see graph), high global exposure S&P500 companies have under-performed their peers by 530 bps (11.5% vs 6.2%). In terms of sector exposure, Information Technology and Materials source most of their sales from international markets (58% and 55% respectively). On the other hand, the Utilities sector and Real Estate exhibit the highest domestic sales exposure amongst sectors (97% and 86% respectively), thus appearing less vulnerable to trade frictions.
Valuation multiples (see table on page 12 for details) suggest the IT sector maintains its growth premium, even as it remains heavily exposed to international markets. Indeed, hardware tech and software industries remain over-valued in Price/Earnings (+20% and 43% above 10Yr average respectively). In contrast, idiosyncratic factors, such as oil inventories and trade tensions, depress the valuations of certain sectors that remain vulnerable on global developments such as Energy (P/E vs 10Yr avg:-21%, P/B vs 10Yr avg: -11%) and Autos (-19% and -27% respectively).