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My favourite research each US earnings season is the so-called Beige Book produced by David Kostin and his team at Goldman Sachs. They wade through earnings calls and transcripts and try to distil the most important themes that emerged. They also pull out a lot of the best quotes. They are being well paid for their endeavours, but this is certainly a very useful service.

So, here are the four themes that the Goldman team picked up on in this season’s earnings calls, with some pungent CEO commentary.

1) Cash use: Firms had to say something about how they would use their tax savings.

Different CEOs had different priorities. Some will spend, while others are talking about returning cash to shareholders, which is not at all surprising. Perhaps the most telling statistic quoted is that the Goldman Buyback Desk recently had its two highest volume weeks on record, as the S&P 500 suffered its first correction in nearly two years. As historically buyback activity tends to be higher when share prices are higher, and vice versa, which is exactly the opposite of how managements should behave, it is at least comforting that managers seem to have faith in their own prospects. 

Companies most committed to raising capex included 3M (expected capex goes up by $100m to a range of $1.5bn-$1.8bn), Johnson & Johnson, National Oilwell Varco (which is not yet ready to pay more to shareholders given its hopes to raise capex and the possibilities for M&A), McDonald’s (which was emphatic that investment would come ahead of any dividends or share buybacks) and Northrop Grumman.

Some big tech names featured in the list of companies committing to more share purchases, including Cisco, Alphabet, eBay, Juniper Networks and Visa. It is an interesting question whether it is good or bad that tech companies, not currently in any trouble with their shareholders, think that buybacks may be the best use of their cash.

2) Persistence of tax savings: Will the tax cut really percolate down to the bottom line?

This was the beginning of what should be a fascinating debate. Earnings calls "supported the idea that part of the tax savings could be eroded by higher wages". But there were mixed views on "the likelihood of savings being competed away via lower prices", with branded products in a stronger position.

A long roll call of companies announced bonuses and/or wage increases (particularly for those at the bottom of the pay scale). This quote from BNY Mellon expresses what is going on:

Moving minimum wage to $15, I mean, I’d love to sit here and tell you that we’re leading this country to some place where it isn’t, but that’s not the case. It’s just, others have done it and more will do it. It feels like the right thing to do. And so it feels like sharing that portion with our employees is the right thing to do relative to the tax law change.

As for the logic of whether the benefits will be competed away, read this contribution from Discover Financial Services:

In terms of whether things would be competed away, I think that it’s likely that some will be competed away. I personally think it would not be reasonable for it all to be competed away or for anything to happen very quickly . . . . But even the industry tends to have a better return than other parts of financial services, and
so if you just — if you were a theorist and said, well, all excess profits get competed away, that would not be sustainable and it has been because we’re differentiated, we’re a brand, there’s a lot of reasons.

3) Economic growth: Managers seem to share a Trump-like optimism that the US economy will grow above trend this year.

CEOs and other corporate officers were only too happy to stoke the optimism for the economy (although of course that might also mean pessimism about a return to inflation and higher interest rates). Some choice quotes:

I’m very optimistic that we’re going to overachieve most economic
assessments of 2018. You’re finally starting to see some economists get out there and very bravely just talk about 2.7% growth, I think that is very low. And if we don’t have a three handle on economic growth this year, I’ll be sorely disappointed and surprised. (AT&T)

There is clearly very deep and very resilient demand for apartment living in our urban and highly walkable suburban markets, which continues to be powered by an expanding economy, which has driven unemployment to record lows and has ignited wage growth that had been dormant for much of the recovery. (Equity Residential)

Even though interest rates have started to creep up and the tax
plan has thrown a few wrinkles across the landscape, there remain many positive forces continuing to push demand higher. The underlying economy looks to be gaining speed, and the tax cut has the potential to add fuel to this engine. Employment trends are certainly favorable, and wages are showing some signs of growth, which would also be a positive. Given these strong underpinnings, the potential for demand to expand further, particularly among the big bookend demographics of millennials and boomers, is certainly very real. (Pulte Group)

4) Commodity price inflation: companies that buy a lot of raw materials think it is going to be a problem. 

The price of oil and metals has been rising, and that led to fears about margin pressure for big users of commodities. Others suggested that they would be able to pass on the price increases — implying inflation for consumers. 

I think, as you look at the current trends, we got material costs going up, steel being the primary one, but you got aluminum, you got oil, you’ve got other of the commodities which we haven’t, as an industry, been able to really pass through in a large way, that I think will equal out; historically, it has. (Acuity Brands)

All the price increases that we’ve put in were based on the costs and our anticipation of where it is. We’ve had — oil and commodities seemed to have gone up, but then oil’s dropped back down. I mean, if I could guess the oil prices, I wouldn’t be doing this job. I can tell you that last year, we had huge inflation in almost every product and marketplace and we implemented pricing to cover it and whatever happens this year we’ll react to it again. (Mohawk Industries)

I-ta-lia! 

Entering the year, Italy was lined up to be the next sum of all fears. Its election is next week, there is no clear winner, there are populists and rogues on the menu, and the country has a messy banking system and a worrying amount of outstanding debt. Between Silvio Berlusconi and Beppe Grillo (a professional clown), the cast of characters seemed perfectly calculated to scare the markets witless. It has not worked out that way. No news has been good news.

This is how the FTSE MIB index of Italian stocks has fared compared to the FTSE-Eurofirst 300 index, which covers the continent, since the beginning of last year:

As for the spread of Italian bond yields over bunds, the impression is that political risk is decreasing as the election approaches:

There have been a number of incidents in the post-crisis period when markets have braced ahead of an election, and this looks nothing like them. There is no obvious concern at work. To be clear, perceptions of Italy’s risk are still changed utterly compared to the view before crises hit the US and the eurozone. This is what that spread has looked like since the start of the euro in 1999: 

But the basic point remains that there are plainly few nerves about the approach of this election. If there were, then the spread would be widening, and Italian stocks would be underperforming the rest of Europe. In both cases, the opposite is true.

If we look at ISM surveys of manufacturers, it looks as though worries may all have been misplaced. Italy seems braced almost to grow its way out of trouble:

Italy’s messy politics have not stopped executives from feeling more optimistic than at any time since the crisis started. Manufacturers are even more optimistic than they are in the US, if the survey is to be believed.

Why are markets so relaxed? Claudio Ferrarese, portfolio manager with Fidelity International, weighs the issues this way:

By now, most people agree that a clear winner of the Italian election on 4th March is unlikely due to the new electoral system. A probable hung parliament will create the necessity of broad coalition talks. 

It’s an Italian election and there is always the risk of surprises. For instance, it could be a right-wing victory with Berlusconi (ousted from Parliament and barred from holding office until 2019) potentially one of the main stakeholders and likely kingmaker. The Five Star Movement (M5S), which received a lot of press coverage over the past few years due to their populist manifesto, has taken ground from Berlusconi, especially in the south of Italy. But an outright victory of M5S would still be difficult to achieve under the recently reformed electoral law.

Italy’s political system is famously messy, and prone to change prime ministers at short intervals, but it is also stable. Companies and investors have grown used to dealing with louder political noise.

But still, the stakes are high. This analysis from IDEA Global also suggests that the focus on M5S, perhaps natural given its poll ratings and the fact that it was launched by a comedian, may have been misplaced. Instead, there should perhaps be more concern about the possibility of a far more euro-hostile Centre-Right coming to power:

M5S leader Di Maio, who at the end of 2017 declared his support for a referendum to jettison Eurozone membership, appears to have done a volte face only last month by abandoning the party’s long-standing threat to dump the single currency. Clearly the leadership has been forced to become more pragmatic in the wake of the instability already wrought by the UK’s decision to ’Brexit’, and in view of the potential loss of inward foreign investment and economic instability that could arise in Italy, should it try anything so silly. The party is also sounding more conciliatory about teaming up with other rival parties to form a coalition, should it come to that, and has even mooted the possibility of forming, in essence, a grand coalition that includes both the PD and FI. This may not be practical but at least it’s being considered. So it seems to have shed its mantle of being the party to fear, with that cloak now wrapped snugly around the right wing Northern League (NL) party that’s in alliance with the FI [Berlusconi’s Forza Italia] and whose leadership has categorically stated that work should begin on leaving the Eurozone if the centre-right wins the March 4 election.

As Italian debt remains more than 130 per cent of GDP, this sounds like a reason to regard any centre-right government as potentially reigniting risks to the eurozone and the European economy. For the long-term, Lorenzo Codogno makes clear in a blog for the LSE that the Italian body politic is very unhealthy:

How did Italy get to this point of political fragmentation and growing anti-European sentiment? A decade ago, Italy was among the most pro-euro countries in Europe, with a long history of being one of the staunchest advocates for further integration. In the most recent Eurobarometer survey, only 59 Italians out of 100 were in favour of a European economic and monetary union with one single currency, the euro. It was the most Eurosceptic outcome among the countries participating in monetary union.

He points out that Italian GDP remains 5.7 per cent lower than its pre-crisis peak. I suggest that this passage, which I will quote at length, should worry more or less anyone with an interest in continuing strong performance for eurozone assets:

The popular narrative is that Brussels contributed to deepening the crisis by forcing Italy to implement tight fiscal policies or so-called austerity. Under the pressure of financial markets during the European sovereign debt crisis, Italy increased the structural (cyclically-adjusted and net of one-offs) primary balance, which is the best measure of fiscal stance, from 0.6% in 2009 to 4.0% in 2013, with an almost 2.5 percentage point tightening in 2012 alone. However, since 2013 there has been a moderately expansionary policy, which has brought this metric down to 1.7% in 2017, according to European Commission data.

Even after the elections, no matter which party or coalition wins, the Italian government is unlikely to tackle the issue of the high debt-to-GDP ratio forcefully and decidedly. The Partito Democratico (Democratic Party) is mostly pro-European, although with some populist and anti-austerity flourishes (former PM Renzi repeatedly tried to increase the deficit leeway), and mostly pro-reform, although the positive momentum has declined sharply.

Berlusconi’s Forza Italia is mostly pro-European as well, although with a Eurosceptic spin. The introduction of a parallel currency (Am-lire) was mainly Berlusconi’s idea, not his party’s. Plans to sharply reduce taxation and partly unwind the pension reform are in contradiction with the stated objective of a 4% primary surplus (against an estimated 1.5% in 2017). Its overall stance towards the EU remains constructive, however, and there are no plans for Italexit.

A Northern League-led government would make the stance towards the EU and the euro more problematic. Italexit has been toned down, but not entirely, and the introduction of a parallel currency (mini-bot) has not been dismissed. The Five Star Movement appears to have put aside the idea of a referendum on the euro and the proposal for a parallel currency, but they could resurface at a later stage. The fight against fiscal rules and the so-called European straitjacket would mount.

The bottom line, perhaps, is that we should be glad that markets are no longer taking fright every time a populist appears on a national ballot. But the degree of calmness looks excessive to me. Whatever the election result, there appears to be far more room on the down-side than on the up-side.

And of course, we should remember the theory of the old British prime minister that soccer can be critical to the national mood. He won re-election in 1966, when England won the World Cup for the only time in history, and lost in 1970 when an apparently better England team was knocked out in the quarter-finals by Germany. Italy’s World Cup record is of course somewhat better than England’s, so its failure to qualify for the World Cup finals this year, for the first time since 1958, might well leave the populace in the mood to administer a populist kick to the powers that be.

In the interests of avoiding that, they should perhaps watch this:

authersnote@ft.com

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