How sustainable are the compelling US fundamentals?

The raft of bleak earnings reports from US banks will have left a sour taste in the mouths of investors hoping for a turnaround after some decent economic data from the world's biggest economy.

One by one, big American financials filed reports that fell far short of the previous year's mark. JP Morgan Chase kicked off the season by issuing interims that were 23% down.  It was closely followed by Wall Street giants Goldman Sachs (-58%) and Citibank (-7%).

With the S&P 500 hovering above a healthy 13,000 in the days that lead up to this grim round of reports, it will not have felt too irrational to some investors to have hoped for a bit of positive news.

But with only Bank of America and Morgan Stanley able to buck the downward trend, fears about a broader drop off in earnings are brewing.

Reasons to fret?

While the obvious fears - the eurozone crisis and the possibility of the US being pulled into the wider global slowdown - persist, the outcome of America's quarter four earnings season is not a foregone conclusion. 

Investors only have to look to Apple, which on Monday published a blockbuster set of results that left analysts dumbfounded, for evidence that life remains in US stocks.

That is not to say that America's biggest enterprises do not face headwinds; margins are being squeezed as companies hire and spend more to diversify their offering and grab hold of floating market share, and the downturn in Europe is hitting exports, which according to the latest round of estimates fell by around 7% at 200's end.  Both of these could easily continue or intensify, with the most likely casualty being Europe given that its half-life is growing shorter by the day.

But so far, only 10% of corporate America has actually reported to shareholders, a mere fraction of the overall market and a sample that is skewed by the gloomy data pouring from financials.

Non-financial earnings per share have managed to remain ahead of consensus estimates, and more positive surprises like the one that cheered Apple investors could easily cancel out an acceleration in analysts' downgrades.

Thirdly, according to an analysis by Nomura, margin squeezes borne out of a pick up in business re-investment and an increase in spending typically boost the wider economy.  The investment bank believes this process may already be underway in the States (see chart below), and is one of the reasons it feels the US equity market has some of the best fundamentals around.

Sustainability

To Nomura, what is key is how sustainable these better fundamentals are over 2012.  America has already had a taste of what a renewed slowdown could feel like (the August growth numbers and depressed consumer business and confidence surverys that followed), and ultimately, feelings about the US' 'better' growth outlook are all relative. 

While increased spending and hiring and a stream of more positive earnings reports will help sustain the positive sentiment around America, Nomura says the country needs an added kicker, and hopes that movements in risk premiums will provide this.

The bank's Ian Scott explained: 'Lowered volatility should mean lower risk premiums.  We think equity risk premiums have further to fall to reflect ongoing declines in volatility.'

This means that concerns linked to a peak in profit margins are largely being driven by movements in risk premium, rather than earnings.   Declines in implied volatility hint that it is now time for a catch up in the form of lower risk premiums, followed by higher stock prices.