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Brexit’s Impact on US Earnings Season

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As the stock market has largely digested the fallout from the Brexit relatively unscathed, attention is likely to shift to US earnings, which begin in earnest in less than two weeks. The effects of Brexit have led to two immediate ramifications for US earnings: a stronger US dollar versus the British Pound (and to a lesser extent the Euro) and the realization that the Fed will not raise rates as soon as some had expected. Against a backdrop of a market trading at above historical valuations, there are likely to be winners and losers in the upcoming earnings season.

A stronger US dollar will likely effect companies with a large percentage of revenues coming from Europe, Britain in particular. Before Brexit, the US dollar had declined in 2016, giving a much needed boost to slower growing companies with European exposure. Earnings expectations had increased prior to Brexit for such companies.  However, now there is heightened risk of companies either missing earnings or giving cautious guidance due to the recently resurgent dollar. Investors would be wise to scrutinize commentary on the strong dollar as companies report earnings.

The Brexit fallout immediately reduced already diminished expectations that the Federal Reserve will raise interest rates any time soon. Right now, the odds of the Fed raising rates in 2016 have fallen below 50%, and expectations of a Fed rate rise in 2017 are diminishing as well. This dynamic should help to keep a bid under stocks with bond like yields. Also, lower yields should help keep a floor under energy prices. This is a welcome reprieve from earlier in the year when oil prices collapsed to under $30 per barrel, currently oil is trading at $47 per barrel. Bank stocks will be in focus as investors weigh in on the downside of lower interest rates for a longer period against the positives of low valuations and high yields.

The optimal companies to invest in have the potential to beat earnings estimates due to the underlying strength of their businesses. Faster growing companies are better able to absorb the hit on earnings due to recent dollar strength. The biggest concern facing investors is that a great majority of stocks in the market are fully valued. This makes most multinational securities’ earnings susceptible to swings in currency. Most domestically focused stocks are fully priced as well, leaving investors with few appealing investment opportunities.

Best Bet: Facebook (NYSE: FB) – Facebook’s advertising business continues to grow at a blistering pace. The first quarter saw revenue jump 52%, and would have been even higher if not for currency effects. Instagram ads continue to ramp, as well as premium ad formats like video ads. Given its superior growth profile, Facebook is better able to whether currency hits from the strong dollar than many other technology stocks. Considering Facebook’s forward PE ratio of 25 times earnings, Facebook seems like a good bet.

Worth a look: Wells Fargo (NYSE: WFC) – Wells Fargo stock trades near its 52 week low, and sports a nice dividend yield of 3.2%. Its valuation is reasonable at 10.5 times forward earnings. The extended low rate environment is likely to be a drag on growth however. Therefore Wells Fargo’s current low valuation may be appropriate. Given investors’ current dour view on banks, Wells Fargo may represent an appealing contrarian bet to some investors.

Overall, aside from a few opportunities, investors for the most part are better off waiting for valuations to become more compelling before jumping in with both feet. Opportunities always present themselves, however it may be some time yet before they arrive in bunches.

 

Disclosure:

All of the ideas expressed in this article are the opinions of Ideal Asset Management LLC

Before trading on any of the information in this article, consider consulting your financial advisor to make it suits your financial goals

Ideal Asset Management owns shares of FB and WFC for its clients

All investments carry the risk of loss

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