Will revenue growth start to compensate for margins?

Equities drifted lower as the day wore on, mainly due to a combination of apathy and the headlines coming from the Ukraine. There were a few bits of macro news on Tuesday for investors to chew on, the first being UK inflation falling to a four-year low of 1.6% for the month of March. On Wednesday, wage numbers are forecast to show average earnings growth picking up to 1.8% over the same period. 

If the number comes in line with those expectations it will be the first time since 2010 that earnings have out paced inflation. If earnings continue to rise above the rate of inflation, this should see the recent fall in the consumer price index start to stabilise, and we may even see inflation start to tick up from here back towards the Bank of England target of 2%.

Wednesday sees the release of the final euro area inflation data for March; hopes are for a month-on-month increase of 0.3%. After Mario Draghi’s comments at the weekend, expectations amongst economists are now focusing on June for the next ECB rate cut. June is when the ECB releases updated model results for its mid-term inflation estimates. 

My personal view is that now Mario Draghi has talked so openly about the possibility of flat or negative interest rates, why wait for the market to call his bluff. On Tuesday Germany released the latest ZEW survey that showed a slip in investor confidence during April; if investor confidence is falling in Germany, this should ease the resistance from Germany for the ECB to act. My bet is the next cut in European interest rates comes at the following ECB meeting, on May the 8th.

America also reported data that indicates inflationary pressures remain generally benign. Earnings from Coca Cola, which beat analyst expectations, and Johnson & Johnson coming in line with expectations, led JP Morgan to comment that they felt reasonably optimistic about the earnings season. It is possibly a little early to call it but so far results have generally gone according to plan. One thing worth bearing in mind during this earnings season is the mix between revenue and earnings. Over the past few years, market commentators have pointed out that earnings estimates have been met as companies have squeezed out costs to maintain margins. The talk is often a concern that margins are at a peak and this substituting of revenue growth by efficiency costs can’t carry on forever. If the improvement in the global economy does drive revenue growth, companies may be able to suffer a modest amount of margin compression and still maintain profit growth. 

The focus for traders and investors on Wednesday morning will be the release of China’s Q1 2014 quarter-on-quarter and year-on-year growth rates. Estimates are for a year-on-year growth of 7.3% and for 1.4% for the first quarter.

Posted on April 16, 2014 .