Market Note – October 24, 2022

By Hightower Great Lakes on October 24, 2022

Corporate Heavyweights Reporting Q3 Earnings this Week

More than 24% of the S&P 500 market cap has reported earnings, and another 168 companies are set to report this week.

Companies that are beating on both revenues and EPS are outperforming the market by +0.7%, while ones missing on both are underperforming by -6.2%.¹

As expected, energy names have contributed the strongest y/y growth across EPS and revenue. Communication services and financials have reported the slowest y/y growth in revenue and contracting earnings.

There are many companies still left to report; emerging themes have included the impact of higher rates – positive for financials, negative for companies issuing new debt. Financials have issued higher credit loss provisions, in case of rising delinquencies.

Pricing strength and consumer resilience have battled against higher labor and freight costs. The demand picture is mixed, with some companies reporting subscriber growth and others reporting losses – meanwhile, elevated costs are relatively consistent.

The duration of pricing power remains a concern for investors, especially in companies experiencing a drop in demand.

FX headwinds have impacted some Q3 earnings and forced companies to narrow/lower guidance.

A final theme has been the low sentiment and low expectations, which has contributed to 69% of companies beating earnings expectations.

Most CEOs have remained conservative in their guidance and have focused on cost-saving plans, given the uncertain environment.

The stock market has reacted positively to a combined better-than-feared earnings reports and technical factors in markets. The S&P 500 increased +4.75% last week, with both value and growth participating in the rally.

This week, the stakes are high, and heavyweight reporters include GOOGL, META, AMZN, MSFT, V, KO, MRK, XOM and CVX.

Steady Demand, Better Supply Chains, Tight Labor Market

In aggregate, corporate margins have contracted y/y, but revenues and earnings growth are positive. A healthy consumer backdrop and +2-3% q/q real Q3 GDP growth expectations have supported healthy profits. Industrial production increased +0.4% m/m in September.

Falling weekly jobless claims and 4 million more job openings than people unemployed continues to indicate a tight labor market.

While freight costs are poised to see a sharp downturn within the next couple of quarters and most commodity costs have retracted from their H1 peaks, two significant headwinds remain: a demand-slowdown from higher interest rates and elevated labor costs.

Labor costs are now 14% above their pre-COVID trend, and job openings remain elevated.

These higher labor costs will continue to impact company bottom-lines and, coupled with a broader demand-slowdown, could pressure companies to reduce overhead.

Nominal revenues are 11% above pre-COVID trends, but real revenues are up just 2%. If the Fed succeeds in slowing demand further, companies may be forced to cut jobs as a form of cost-saving.

So far, consumer demand has been resilient in the face of rising rates – particularly in the service economy, which represents 80% of GDP (think restaurants, travel, entertainment).

Healthy household balance sheets, along with jobs and wage growth, are fueling the demand. Only the interest-rate sensitive components of GDP (housing, autos, capex) have materially responded to the Fed’s rate hikes.

The Fed is standing firm in their fight against inflation, trying to avoid a stop-and-go policy scenario, which has resulted in expectations for a peak 5.0-5.25% fed funds target (currently 3.0-3.25%).

We could see a long runway for growth once inflation is brought down to normal levels, but that may require another 200 bps of rate hikes to achieve.

Defining “Low Sentiment, Low Expectations”

According to the Conference Board Survey, 98% of CEOs expect a recession.² In other words, this may be the most anticipated recession in history.

Implications are that businesses are planning for a recession and so is the U.S. consumer, by saving. There is still $2.2 trillion in savings accounts.

The S&P 500 is trading around 15.6x their projected earnings, compared to 21x at the end of 2021.

Lower valuations offer some protection to declining earnings, but any estimate of where earnings go from here is just a guess, in our view.

For long-term investors, there are plenty of opportunities to invest at historically low multiples and high yields with noteworthy future catalysts.

U.S. Releases FY22 Budget Results

The U.S. final fiscal year 2022 budget decreased $1.4 trillion – representing half of the FY21 budget deficit and the largest annual decrease in history.

This progress is unlikely to be repeated in 2023 as rising interest rates have placed a significant burden on government debt financing.

In the FY23 U.S. budget, 30-day interest rates were projected to rise from 0.2% in FY22 to 0.9% in FY23 – the current rate is 4.0%.

The 2023 budget also included projections for CPI falling sharply to 2.3% y/y (currently projected as +8.0% y/y in 2022) and real GDP at +2.8% y/y (currently projected as +1.7% y/y in 2022.)³

These projections will almost certainly be revised, and fiscal policy impacted – one reason why this year’s midterms have great macro implications.

Biden SPR Policy Update

President Biden said, last Wednesday, that the energy department would begin purchasing oil to refill the U.S. Strategic Petroleum Reserve (SPR) at prices in the $67-$72 range or lower.

This promise is meant to encourage more drilling, as producers know there is a fixed buyer waiting at those lower prices. However, oil companies still prefer to capture higher prices while they are in place.

Drawing reserves lowers short-term prices (by increasing supply) and further dissuades companies from investing in new production.

Most energy companies have a breakeven price around $40-$45/barrel – shareholder return policies and profits are sustainable down to those levels (far below the White House’s purchase offer).

WTI crude oil futures remain above $83 and Brent crude oil futures above $90 per barrel.

15 million barrels remain to be delivered in December, completing a total sale of 180 million barrels from the SPR. The energy department could further draw barrels, if necessary, despite a 38-year low in reserves.

This Week: Rising Rates vs. Core PCE (Fed’s Preferred Measure of Inflation)

Undeterred by the weekly headlines – whether it be inflation peaking, a possible Fed pivot, or a fear of overtightening – Treasury yields have stubbornly risen higher since the late July rally.

While the intra-week moves have been volatile, in aggregate, yields continue higher. Since August 1^st, the two- and ten-year yields have risen 162 and 165 bps respectively, while the 2/10 spread has remained persistently inverted.

One example of the intra-week moves came with Friday’s news of a possible Fed pivot in the Wall Street Journal, along with Fed President of San Francisco Mary Daly’s (non-voting) calls for decreases in size to 25 and 50 bps hikes.⁴

This caused shorter-dated yields to sink and pushed investors to cut peak policy estimates. Regardless of the news, the Fed will have a close eye on their preferred measure of inflation, Core PCE (est. 5.2%), which is released on Thursday.

Chart 1: Fed’s Peak Policy Rate Projected around 5.0%, Up From 4.7% the Week Prior⁵

The Week Ahead

Earnings – Tuesday: GOOG, V, MSFT, KO, GE, GM, UPS, RTX, MMM, HAL, VLO, KMB, SHW, TXN. Wednesday: BA, F, META, ODFL, HLT, KHC. Thursday: AAPL, INTC, CAT, HON, MCD, MA, CARR, LUV. Friday: CVX, XOM, LHX.

Economics – Monday: Consumer Confidence (October), Preliminary PMI (October). Tuesday: New Home Sales (September). Wednesday: Q3 GDP. Thursday: PCE (September), Personal Income (September), Final Michigan Sentiment (October)

Return for Selected Indices⁶

Click here to read last week’s Market Note (10/17).

SOURCES

¹ Source: Credit Suisse (October 24, 2022).

² Source: The Conference Board (October 24, 2022).

³ Source: The White House (October 24, 2022).

⁴ Source: Wall Street Journal (October 24, 2022).

⁵ Source: Bloomberg (chart) (October 24, 2022).

⁶ Source: Bloomberg (October 24, 2022).

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.