Wentz Weekly: Earnings Wind Down While Fed Back in Focus

Wentz Weekly Insights
Earnings Wind Down While Fed Back in Focus with Jackson Hole Economic Symposium

Nearly all S&P 500 companies have reported second quarter earnings results and the results have been very mixed. Company’s earnings have increased 6.7% in aggregate from the same period a year ago, which is good considering the expectation before companies began releasing results was 4% but is also the slowest quarter of growth since late 2020. Also good is about 75% of companies reporting have posted better than expected earnings, but below the five-year average of 77%. Breaking it down to the sector level, earnings growth has been driven by the energy, materials, and industrial sectors. Not surprising considering these sectors are highly cyclical and are direct beneficiaries of the surge in prices seen so far in 2022.

In addition, 70% of S&P 500 companies have reported revenues above estimates, above the 5-year average of 69%. The blended growth in revenues is 13.6%, better than the 10.1% growth that was expected before earnings season began and will mark the sixth consecutive quarter of revenue growth above 10%. All 11 sectors are seeing revenue growth with energy leading the way driven by higher oil prices.

What has been most surprising is the resiliency in company’s profit margins. Although the profit margin on the S&P 500 has fallen from 13.1% in the same quarter a year ago, second quarter net profit margin is estimated to be 12.3%, matching the margin from the first quarter despite the number of price increases seen throughout the economy. This is still above the 5-year average of 11.2% and would be the fifth highest profits margin since data started in 2008 by FactSet.

The bad news is companies and analysts are lowering their forecasts for the second half of 2022 and full year 2023 and have been doing so consistently since the start of earnings season. The aggregate earnings per share on the S&P 500 peaked in mid-June at a record high of $240, but as of mid-August has come down about 2% to $236 per share. Margin compression is the culprit as companies deal with higher costs – everything from raw materials and transportation to labor. Margins are estimated to be 12.8% for the full year 2022, down from the 13.2% estimates at the beginning of the year, and 13.3% in 2023, down from 13.8% in the beginning of the year estimate.

Overall the bar was set low for second quarter earnings. Markets have rewarded the companies that posted better earnings than expected with larger prices increases than average, while the increase in stock prices of those with earnings less than expected were punished less than average.

With earnings season behind us, the markets are now anxious to hear from Jerome Powell at the Jackson Hole Economic Symposium on Friday. Historically the event has been a time for policymakers to announce major policy changes. We don’t expect that this week, but investors will be focused on what cues Chairman Powell give about the direction of rates for 2022 and more importantly what happens in 2023. There is a wide expectation Powell will push back on the “Fed pivot” (changing policy from increasing rates to reducing rates) narrative that has helped markets rally from the lows just two months ago. If this is the case, expect bond yields to move higher with a flatter yield curve and a further pullback in stocks, which is where portfolios could benefit from a more defensive stance.

Week in Review:

It was a slower start to the week last Monday, but after several hours markets started to move higher and closed near the highs of the day. It was a quieter day from a headline perspective but economic data out of China and the U.S. manufacturing disappointed largely to the downside. Breadth was weaker on the day with advancing to declining stocks close to 1 to 1. Growth was in favor again with the NASDAQ finishing up 0.62% and the S&P 500 up 0.40%.

The number of new housing starts disappointing to the downside while industrial production was better than expected with markets opening mixed on Tuesday after reports from the retail sector (Walmart and Home Depot) were better than expected. Asian markets got a boost after the Chinese government said new onshore bonds issued from select property developers will be guaranteed. Outside of that, meme stocks and the highest shorted stocks received increased attention after seeing sharp increases from several stocks in that space. Walmart and Home Depot helped lift the Dow 0.71% higher, outperforming the NASDAQ’s 0.19% decline. The S&P 500 originally rose but met some resistance at its 200 day moving average and reversed course from there, closing up 0.19%.

Hotter than expected inflation data out of Europe had global markets lower Wednesday which spilled over to the U.S., in addition to mixed earnings from Target but offset by a retail sales report that came in slightly below expectations at the headline level but stronger after analyzing the underlying details. The FOMC meeting minutes revealed a mixed message on how far to tighten financial conditions, but one thing was common – inflation is still too high. The S&P 500 decline 0.72% on the day with the weakest market breadth since late June.

Thursday morning data included unemployment claims that remained relatively unchanged in the latest week, manufacturing conditions from the Philadelphia region that grew slightly, according to the Philly Fed’s survey, and existing home sales in July that fell to the slowest pace since 2014 (excluding April – June 2020 during the beginning of the pandemic). Fed speak throughout the day emphasized policymakers do not want to get complacent and need to be “completely convinced” inflation is coming down before slowing rate increases. Stocks traded back and forth but finished slightly higher with the S&P 500 up 0.23% and energy sector the clear standout, gaining 2.53% on the day.

There was a lack of headlines on Friday beside inflation data from Europe that was higher than expected at 40-year highs with global bond yields higher. Markets moved to a risk off mode on Friday with strong selling as declining to advancing volume was 6.1 to 1. The 10-year treasury traded back to 3.0% for the first time in a month with the curve steepening and equities finishing lower across the board, the S&P 500 finished 1.29% lower.

Stocks were lower for the week for the first time in five weeks. A more hawkish tone from Fed policymakers and global inflation that was higher than expected sent treasury yields higher for the week with the 10-year hitting 3.0% again briefly before settling the week at 2.99%. The dollar had a strong week while oil was about 2% lower. The major U.S. indices finished as follow: Dow -0.16%, S&P 500 -1.21%, NASDAQ -2.62%, and Russell 2000 -2.94%.

Recent Economic Data

• U.S. retail and food services sales were $682.8 billion in July, unchanged compared to the month prior. This follows a 0.8% increase in June, which was revised down from a 1.0% increase, and is compared to the 0.1% increase expected. The details of the report were mixed but the trend of increasing spending on services and things that benefit from the reopening of the economy and away from goods continues. Vehicle sales declined 1.6% as severe shortages continue while gasoline sales fell 1.8% due to lower prices at the pump. Excluding these two volatile categories, sales rose a solid 0.7%. The strength was driven by sales of building materials/gardening increasing 1.5%, miscellaneous store sales up 1.5% and e-commerce sales up 2.7%, possibly driven by Amazon Prime Day which Amazon said was the largest ever. This was offset by a weak month in sales of apparel and general merchandise stores as retailers markdown excess inventories. Compared to a year ago sales are 10.3% higher and 9.3% higher excluding autos and gasoline and with July year-over-year inflation at 8.5%, real retail sales moved back into positive territory, but with a small 0.8% increase.
• Existing home sales fell 5.9% in July to a seasonally adjusted annualized pace of 4.810 million and are down 20.2% from the same month a year ago. This is the slowest sales pace of existing homes since 2014, excluding April – June 2020 when the beginning of the pandemic prevented prospective home buyers from looking for homes. The inventory of unsold homes rose 4.8% to 1.310 million, flat from a year ago ending a 36 month streak of falling inventories, and is equal to 3.3 months supply at the current sales pace. The median home price declined slightly in the month to $403,800, but still up 10.8% from a year ago. Despite the slower sales pace, demand remains high with 82% of existing homes sold on the market for less than a month.
• In July there were 1.446 million housing starts, on an annualized basis, 9.6% below June’s rate, 8.1% below the rate a year ago and the slowest pace in 17 months as home builders deal with lower affordability for home buyers, higher construction costs, and ongoing supply chain issues. Single family housing starts was at an annualized rate of 916,000, down 10.1% from June while multi-family homes were 514,000 annualized. However, the number of homes under construction remains near the highest levels on record, going back over 50 years, while the number of homes authorized but not yet built also at the highest on record going back to 1999. The amount of permits in July were at an annualized rate of 1.674 million, 1.3% below June’s level but 1.1% above the rate a year ago.
• The August National Association of Home builders Housing Market Index was 49 versus the 55 expected and compared to 55 in July. An index level below 50 indicates contracting activity while above 50 indicates expanding and growing conditions. August was the first time the index fell below 50 since early 2020 when it fell below 50 briefly. Traffic hit results the most as traffic was the lowest since 2014. Ongoing growth in construction costs and higher mortgage rates have weakened sentiment on home builders.
• The Empire State Manufacturing survey general conditions index for August was another disappointment with the index at -31.3, dropping a staggering 42.4 points. The report says the decline was due to a “plunge” in new orders and shipments, with unfilled orders declining and delivery times remaining steady for the first time in nearly 2 years. The positive news was labor market indicators improved and prices pressures, although they are still elevated, came down.
• The August Philadelphia Fed manufacturing survey general conditions index was at 6.2, returning to positive territory after a reading of -12.3 in July and better than expected after a very disappointing Empire State manufacturing survey earlier in the week. Most firms (47%) said conditions were unchanged, 26% said activity improved, and 20% said activity declined. The index for new orders improved but remained in negative territory for the third consecutive month, while employment and price pressure improved but remain elevated.
• Industrial production, which measures the output of the industrial sector including mining, manufacturing, electricity, and gas, rose 0.6%, twice what was expected, driven mostly by manufacturing and mining but was offset by a 0.8% decline in utilities which tends to be more volatile due to weather. The strength in manufacturing in this report is differs from recent manufacturing surveys that suggest activity is contracting. Capacity utilization was 80.3% (above 80% is pretty solid, but over 85% is typically too high and can lead to inflationary bottlenecks with production) and makes it the fourth consecutive quarter above 80%.
• The number of new unemployment claims filed for the week ending August 13 was 250,000, a decline of 2k from the week prior with the four-week average down 3k to 246,750. Continuing claims were 1.437 million, up 7k from the prior week with the four-week average at 1.413 million.

Company News

• Walmart said it has reached a deal with Paramount to offer Paramount+ streaming service as an added perk for its Walmart+ subscription.
• Nikkei Asia is reporting Apple is in talks to produce its watches and MacBooks in Vietnam as it looks to diversify its production away from China. Vietnam is already Apple’s second most important production hub, outside of China, with it already producing the iPads and AirPods.
• Apple said it will hold its annual fall product even on September 7. There is the wide expectation the iPhone 14 will be revealed at the event which may include four models and is expected to include price increases. There are also reports Apple will reveal three Apple Watch models and possibly new Macs and iPads.
• Penn Entertainment said it will exercise its call rights to buyout the remaining 50% portion it did not own of Barstool Sports. The acquisition will be completed in February and will make Barstool a wholly owned subsidiary of Penn. The value of Barstool when the deal was first made in January 2020 was $450 million.

Other News:

• Fed speak picked up in the latest week with several Fed policymakers making public remarks over the second half of the week. The message was the same between the three speakers that the Fed will maintain its hawkish stance. St. Louis President Bullard told the WSJ he is leaning toward supporting a higher 75 basis point increase next month, adding that with good reads on the economy combined with continued high inflation support his decision to continue pushing the fed funds rate into restrictive territory. Kansas City’s George said last month’s inflation data was encouraging but does not want policy makers to become complacent, hinting at support for a higher rate increase. She also said officials need to be “completely convinced that (inflation) number is coming down.” Finally, San Francisco’s Daly said the Fed should raise rates a bit above 3%, compared to the current 2.25%, into 2023 and the raise and hold strategy has historically paid off for the Fed. The FOMC meeting minutes were released last week as well, which pushed back on the “Fed Pivot” narrative, but there were discussions on the risk of raising too much. Separately, Reuters reported the Fed could slow the pace of quantitative tightening (running off its balance sheet) to avoid a hard landing.
• Last week’s earnings focused on retailers and the worry over the past several months has been large increase in inventory amid a slowing consumer and economy. For example, Home Depot said compared to 2019, inventory has increased 77% but sales have increased 42% leaving the company with 35% more inventory. However, markets have not seen this as an issue as the company is buying inventory forward more than in the past. Reports have been largely mixed with some marking down items to work through inventory. Target has been the best example of this. The impact has worked its way to Target’s bottom line with its operating margin at 1.2% in the latest quarter, versus the roughly 8% it averaged in 2021, but it is expected to recover to 6% in the second half of the year as it works through marked down items.
• There has been increased headlines on the progress on the Iran nuclear deal. Iran has said it is closer than it has ever been in securing a deal adding that the remaining issues should not be difficult to resolve. The final text of the European Union’s proposal of the bill has been approved by the U.S. but Iran wants the U.S. to remove its Islamic Revolutionary Guard Corps from the terrorist list, guarantee the deal will be binding regardless of future U.S. administrations, and shutting down the long running investigation into traces of uranium found at nuclear sites. A deal would remove sanctions and bring Iranian crude oil back to global markets that could fill the gap in lost supply due to the European ban of Russia oil by year end.
• Helping bring gasoline prices down in the U.S. has been refiners’ ability to run near full capacity, something executives say they plan to continue. In addition, crude oil has come down from recent highs over recession fears reducing global demand, a slowdown in demand from China due to various reasons such as Covid restrictions, along with increased supply from OPEC and a potential Iran nuclear deal. The average utilization rate at U.S. refineries was 94% in the second quarter and expected to continue, with the largest refiner by capacity, Marathon, running at 97%, helping keep gasoline prices below the spring highs. Despite the correction in oil prices, OPEC Secretary General said the demand environment remains robust and the price decline reflects fears of an economic slowdown and masks physical market fundamentals. OPEC recently raised production slightly in its most recent monthly meeting following pressure from the U.S.
• In what will likely be a preview of the Midterm elections in November, New York is holding its own special election in its Hudson Valley district. This will be the last competitive election before the Midterms. It could prove the Democrats have got a boost from the recent anger over the Supreme Court ruling on abortion and the recently passed legislation on climate change initiatives or show there has been too much damage from inflation and a red wave could be coming.

Did You Know…?

Streaming’s Big Milestone

A move that was accelerated by the pandemic just reached a notable milestone. For the first time ever in July, streaming surpassed cable in terms of viewing time, according to the ratings measurement firm Nielsen and its monthly TV and streaming snapshot report The Gauge. Streaming represented 34.8% of all TV consumption versus 34.4% from cable and 21.6% from broadcast television. Streaming’s share grew 23% from a year ago, when it made up just 28.3% of viewing time, whereas cable and broadcast share declined 8.9% and 9.8% respectively. In total, time spent streaming in July averaged 191 billion minutes per week. Nielsen says Netflix represented the largest share of overall TV viewing for a streaming platform with 8% which was boosted by the 18 billion viewing minutes of Stranger Things by itself. YouTube was a close second at 7.3% followed by Hulu at 3.6% and Amazon Prime Video at 3.0%.

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