We usually find the regular rhythm of corporate earnings a useful cue for stock-taking, but this year has been different with tariff drama rendering actual earnings trends irrelevant, or at least severely deprioritised in terms of market attention.
Yet the Q1 earnings are an interesting counterpoint as they pre-date the Liberation Day drama. While there was an understandable focus on post-quarter trends and forward guidance, what was most useful were the trends which are likely to persist even if tariffs are entirely rolled back.
The US bellwether
The US consumer represents the most important swing factor for global personal consumption and perhaps the most important single motor of the global economy. As the consumer has been under pressure from the severe inflationary pulse of 2022-23, our expectation was, given moderating inflation and sustained decent household income growth, ‘nature would heal itself’ as consumers and small businesses repaired their balance sheets and resumed normal consumption behaviour.
This has not materialised as the economic environment became incrementally tougher. In the universe of large consumer staples companies we track, US organic sales slipped into decline during the quarter.
Meanwhile, broad economy indicators like Mastercard and Visa disclosure on payments volume, Bank of America (BoA) data on spending by their depositors and federal agency surveys continue to be healthier than those for consumer goods and for lower end consumer services.
However, the BoA’s picture of the lower-end consumer corroborates the other data we are looking at. Likewise, data on credit card delinquencies and student loan borrowers indicate growing stress disproportionately on specific demographics.
Through-cycle growth
We are not predicting a recession or a bear market, but there is an important and neglected trend which has been overshadowed by geopolitical histrionics. At a high level the US looks great, with low unemployment, gradually improving bank loan growth, strong productivity growth and (until tariffs) strong corporate confidence.
Therefore, there is a temptation to say that these consumers can be written off as unnecessary for corporate earnings but it will be quite hard to sustain double-digit corporate earnings growth if the fortunes of consumers, who in aggregate make up about 45% of consumer expenditure, continue to weaken.
While it is tempting to dump staples or cyclicals at this point, this is the wrong debate to have. We are not reducing or adding to cyclically exposed companies and we continue to retain a mixture of names with idiosyncratic cyclical exposure like Informa, Amadeus, Experian, Marsh McLennan and Booking, as well as those with more defensive characteristics like Heineken, RELX, Jack Henry and Johnson & Johnson.
The most important common thread is not low defensiveness or high gearing into GDP growth, but the ability to grow market share over time through cycles thanks to an increasingly superior and desirable product. Where we are invested in cyclical companies, they tend to the best player in their market and to be revenue-critical to their enterprise clients.
Even companies which are ostensibly consumer-facing like Booking and L’Oréal are vital partners to their enterprise partners – in this case, hotel owners and retailers – as their brands and networks drive high margin traffic to fixed cost locations which need to keep the cash flowing in to pay shareholders and service leases.
The most important takeaway is that earnings growth is likely to be tougher and more idiosyncratic than in the recent past, reinforcing our desire to double down on companies with differentiated and well-invested products.
Trimming the sails
Our commitment to managing valuation risk is unchanged and remains indifferent to macroeconomic context; we endeavour to ensure that our portfolios enjoy a margin of safety, irrespective of market sentiment, for the same reason that responsible ship captains keep servicing their lifeboats regardless of the weather. Where we have made changes, it has been focused on these quality upgrades.
We have added two holdings which sell to a consumer base (New York Times and Booking). In the case of Booking, it was a straight swap for Airbnb: we have concluded that Booking’s superior investment and diversification make it more defensive and more likely to gain total lodging share over time.
Similarly, New York Times is a well-invested, category defining franchise, with a good history of execution in changing its business model and keeping focused on its ‘true north’ of business excellence in a market which has been utterly upended by the internet.
Performance has been strong in the context of the data above on the lower-income consumer, which has made the economy quite dependent on the cohort of higher-income consumers and capex boom on server capacity. In an unbalanced economy, we are continuing to see good growth from a more balanced portfolio.
While the gap between portfolio growth and index growth is reassuring, it is less important than another gap which we can only track retrospectively: the long-term difference between fundamental compounding by our portfolios and by the wider universe of investable companies is key to our strategy. For now, our portfolio valuation remains attractive in relative and absolute terms despite its outperformance of the broader index since the start of the year.
James Knoedler is portfolio manager of the Evenlode Global Equity fund. The views expressed above should not be taken as investment advice.