Growing signs that stock markets are getting ahead of themselves

JP Morgan, the largest bank in the US by assets, set the tone for global earnings season on Tuesday, reporting that its earnings per share soared an annual 174 per cent in the second quarter. It beat analysts’ expectations by almost a fifth, flattered as the bank freed up some of the money set aside last year for bad loan losses as a result of Covid-19.

Goldman Sachs' results were even more impressive, topping market expectations by almost 50 per cent, as the investment bank raked it in working on a boom in initial public offerings (IPOs) in buoyant markets. Not to be left out, Citigroup, Bank of America and Wells Fargo also beat earnings during the week.

The reception on Wall Street? Most of the banks’ shares fell on the day they reported.

On this side of the Atlantic, target-busting earnings on Friday from Swiss luxury-goods group Richemont, whose brands range from Cartier to Chloé, as its second-quarter sales more than doubled to €4.34 billion, were met with a similar "meh" reaction from investors.

Plunge in Treasury yields reverberates around markets

---

European stocks drop after souring of global economic mood

---

European equities steady but growth jitters persist

---

Rising Covid cases rattle European markets

---

A tough crowd also awaited Mercedes-Benz's parent, Daimler, when it revealed a €5.18 billion quarterly operating profit, up from a €1.68 billion loss a year earlier, and almost €1.3 billion ahead of the consensus call by analysts.

There is little doubt, according to most analysts, that the second quarter is set to mark a peak in the earnings growth cycle

Second-quarter figures were always going to look staggering across publicly quoted companies, given that the world was forced into hibernation amid the Covid-19 shock in the same period last year. But a failure by investors to reward companies for beating even bullish estimates is surely a sign that stock markets had got ahead of themselves.

The benchmark S&P 500 US stocks index jumped 15 per cent in the first six months of the year, its second best first half in 23 years, and continued its onward march to reach a fresh all-time high earlier this week. Europe’s Stoxx 600 index also touched record levels earlier this week after rising 15 per cent from the end of December.

There is little doubt, according to most analysts, that the second quarter is set to mark a peak in the earnings growth cycle. And when that happens, equity markets tend to subsequently dip into the doldrums. The S&P 500 has either declined or delivered a subpar performance in two out of every three quarters after earnings growth topped out, according to data from S&P Dow Jones Indices and Bloomberg going back to 1927.

With the S&P 500 trading at a valuation high last seen just before the dotcom bubble burst in 2000 – at a cyclically adjusted price-earnings ratio (Cape) of about 38 – markets are already pricing in a lot of hope.

The main reason why the global economy hasn't imploded during the pandemic has been the swift action by central banks globally to pump trillions of euro into financial markets

Groups listed on S&P 500 are forecast to post almost 63 per cent annual earnings growth for the second quarter, up from 52 per cent in the first, according to market research group FactSet. If the second-quarter data matches Wall Street’s expectations, it would mark the largest increase since the immediate aftermath of the 2008-2009 global financial crisis.

Companies included in Europe’s Stoxx 600 are expected to post an even more eye-watering 140 per cent growth rate in the coming weeks, according to Bank of America investment strategists.

The main reason why the global economy hasn’t imploded during the pandemic has been the swift action by central banks globally to pump trillions of euro into financial markets, offering safe passage to governments as they have ventured into debt markets to fund unprecedented supports for households and businesses.

The dilemma now is that all that cheap money sloshing around, and recent reopenings of parts of the economy that were put into cold storage during the worst of the pandemic, have led to a spike in inflation – a red flag for central banks – at a time when the world is dealing with a surge in the Delta variant of the virus.

For now central banks are trying not to spook the markets. US Federal Reserve chairman Jerome Powell told Congress this week that it was too soon for the world's most influential central bank to start easing back on its aggressive economic stimulus, as its target for full employment was still a way off.

The conservative voices on the ECB's governing council are currently expected by economists to push through a tapering of its pandemic-related bond-buying programme

But he conceded that he was uncomfortable with the surge in US inflation, running at 5.4 per cent in June, compared with the Fed’s 2 per cent target.

While Powell said the Fed would give plenty of warning before starting to scale back stimulus, discussions had already begun among his monetary policy team last month about timings. Officials are set to accelerate the debate at their next meeting at the end of this month.

Closer to home, the European Central Bank may have abandoned its hawkish bias earlier this month by changing its inflation target from "close to but below" 2 per cent to a "symmetric" 2 per cent target that would allow consumer prices to run above that threshold for a period.

However, the conservative voices on the ECB’s governing council are currently expected by economists to push through a tapering of its pandemic-related bond-buying programme after a meeting in September.

In the meantime it seems that the easy money has been made from the bull run that set in following the sudden Covid collapse in March 2020. And if investors are suddenly unwilling to pile into companies posting target-beating earnings, they’ll surely hammer those that miss over the next few weeks.