Market Note – February 6, 2023

By Hightower Great Lakes on February 6, 2023

Companies Blame Macro Conditions, Markets Indicate Most Headwinds are Transitory

Roughly 50% of the S&P 500 has reported earnings, which are trending towards a -5.3% y/y decline. 70% of companies are beating estimates, which is below the five-year average 77%.¹ Earnings contraction is reflective of challenges, but hardly a doom and gloom scenario as many narratives suggested.

Overall, market reaction to performance misses has been relatively muted. Companies that miss revenues and earnings expectations are underperforming by -1.6%, compared to a historical average -3.1%. Weaker guidance continues to keep expectations low. This week we hear from 18% of the S&P 500.

Chart 1: Earnings Expectations Falling, Consumer Confidence Remains Solid²

Apple (AAPL), Amazon (AMZN), and Alphabet (GOOGL) represent 12% of the S&P 500 and all reported last week. Management teams underscored their challenges; they are focused on cost-cutting and streamlining businesses.

This is a significant shift for some companies, including AAPL, which announced its first year-over-year sales decline since 2019 and lower revenue guidance.

All three companies explained the earnings contraction as due to macroeconomic headwinds, which markets appear to view as transitory. Investors are looking past the well-known macro headwinds to a degree and focusing more on the long-term drivers of profits and margins.

AMZN and GOOGL shared that there’s been a deceleration in cloud-based spending and competitive price pressures, which includes MSFT. Their respective Amazon Web Services, Google Cloud and Microsoft Azure all reported below-expected revenues and decelerating growth.

Overall, the cloud-based storage and servers industry is expected to grow, albeit at a slower pace, and may also interact more closely with corporate investments in new AI tools to support that growth.

We’re staying overweight the consumer – supported by jobs, wages, lower costs (e.g., below-peak mortgage rates, gasoline prices) and reflected in better consumer confidence that has held up well.

We’re finding opportunities within consumer discretionary compounders, industrials supplying secular shortages across service-industries, materials with pricing power, underappreciated financials with low valuations, technology with strong management and long-term tailwinds, and energy – which continues to report record profits and shareholder returns.

The Fed Leaves the Door Open for Future Policy Decisions

Last week, the Fed raised its fed funds target rate 25 bps, which was expected. Fed Chair Jerome Powell sounded positive as he announced a slowdown in the pace of rate hikes. This was the first 25 bps hike since March 2022. Powell acknowledged that recent data has been encouraging, stating, “we can now say for the first time the disinflationary process has started.”³

The goods economy continues to drive disinflation trends, while there are also signs that wage and price growth may have peaked several months ago. Slower wage growth should contribute to a slowdown in services inflation, which still remains too high.

Services inflation is reflective of the strong jobs market. Tight labor conditions and strong wage growth have supported the consumer, while also contributing to continued pressure on services inflation. Services represent roughly 70% of the U.S. economy.

After the FOMC press conference, Fed Chair Powell tried to dispel the narrative for an upcoming pause, saying there will be, “a couple more rate hikes to get to that level we think is appropriately restrictive.” The strong labor market is too high to be consistent with 2% inflation, and uncertainty of how we continue to trend lower remains, after goods disinflation levels.

The Fed’s widely anticipated 25 bps hike resulted in the yield curve largely unchanged. However, Friday’s jobs numbers exacerbated the selloff across the curve, seen as the 10-year yield increased +22 bps in the back half of the week. Both Investment Grade and High Yield spreads continue to tighten from their highs last summer.

Jobs Reports

Unemployment fell to 3.4%, the U.S. economy added 517,000 jobs in January and average hourly earnings grew +4.4%. The new jobs figure saw the highest monthly increase since July – much higher than expected – yet wage growth continued to soften.

There remains a tight labor market, with nearly two job openings for every individual seeking a job opportunity, but the trend in wage growth indicates conditions are loosening. The January ADP report also suggested payroll growth slowed sharply in January.

Further indication that the jobs market is staying resilient for longer-than-expected: the 4-week initial claims trend is the lowest since April 2022. The tight labor market with healthy wage gains is good for the consumer but does not support the Fed’s attempt to slow inflation to 2%.

Chart 2: Slowing Wage Growth and Tight Labor Market⁴

Participation and the average workweek were both up in January – combined with 3.4% unemployment (a 53-year low), this is good news for the economy. During McDonald’s (MCD) earnings report, CEO Chris Kempczinski said, “the consumer, whether it’s in Europe or the U.S., is actually holding up better than we would have probably expected.”

Global Interest Rates

The European Central Bank (ECB) increased its target rate +50 bps and signaled another +50 bps in March, deviating from the U.S. Fed commentary. Europe is experiencing much of the same disinflation as the U.S., but ECB President Christine Lagarde emphasized, “there is an element of catch-up… we know we have ground to cover.” The ECB’s key rate is 2.5%, compared to the U.S. target 4.50% to 4.75%.

Meanwhile, the Bank of England (BoE) signaled it might pause rate hikes unless inflation surprisingly accelerates before their next March meeting. Overall, we are getting closer to global policy makers taking a step back and “sitting on their hands” as they watch their policy decisions impact economies.⁵

China Economic Activity Surges

Manufacturing and services activity in the Chinese economy both expanded in January. Beijing has pivoted from its zero-COVID policy, and is seeking to revive growth, driven by the consumer.

China has experienced a surge in domestic tourism, along with construction activity, yet new export orders and factory production remain in contraction territory – both pivotal for the Chinese economy.⁶

The International Monetary Fund (IMF) recently increased its forecast for 2023 global economic growth, in part, due to China’s re-opening. The IMF expects the global economy to grow +2.9% in 2023, and China’s economy is expected to expand +5.2%.

The Week Ahead

Earnings – Monday: CMI, SWKS. Tuesday: CARR, DD, FTNT, CMG, PAYC, VFC. Wednesday: YUM, EMR, D, WYNN, DIS, MGM, FLT. Thursday: PEP, RL, DUK, EXPE, PYPL, HLT.

Economics – Tuesday: Consumer Credit (December). Friday: Preliminary Michigan Sentiment (February)

Return for Selected Indices⁷

Click here to read last week’s Market Note (1/30).

Disclosures

OCIO is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. OCIO and Hightower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of OCIO and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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¹ Source: The Wall Street Journal. As of February 4, 2023.

² Source1: FactSet (chart). As of February 6, 2023.

³ Source: The Wall Street Journal. As of February 1, 2023.

⁴ Source: FactSet (chart). As of February 6, 2023.

⁵ Source: The Wall Street Journal. As of February 2, 2023.

⁶ Source: The Wall Street Journal. As of January 31, 2023.

⁷ Source: Bloomberg. As of February 6, 2023.