Wentz Weekly Insights
Q1 Earnings Preview – It’s All About The Guidance
Much of the focus for the markets over the past week has been decades high inflation and the continuously more aggressive (but needed) stance the Federal Reserve is taking when it comes to monetary policy in order to bring inflation down. We already know interest rates will go up this year and the Fed’s balance sheet will begin shrinking around summer, but recent comments show the Fed may do several 50 basis point (one basis point is 1/100 of a percent) rate increases by year end and engage in a balance sheet reduction plan at a faster pace.
Federal Reserve Governor Lael Brainard, widely known to be a more dovish member, was the latest Fed member to speak on the Fed’s strong desire to bring inflation down. She made remarks on this being of “paramount” importance and would result in the Fed reducing its balance sheet “at a rapid pace as soon as its May meeting.” Then came the meeting minutes of the Fed’s March 15-16 meeting. Fed members agreed it would be necessary to shrink the balance sheet by $95 billion per month, almost double its highest pace during the 2017-2019 tightening cycle, which would shrink the Fed’s assets by over $1.1 trillion per year. The markets were expected a slower runoff rate, so the news was caught by surprise. This is also unprecedented territory as this is only the second time the Fed has engaged in this activity, and first at this pace, creating uncertainty on what the effect would be on the markets and economy and sending stocks lower for the week.
With details on the initial plan out of the way, market’s attention will shift to earnings this week and the weeks ahead. The first quarter earnings season will (unofficially) begin this week with many of the large banks reporting, among other. After steadily climbing, expectations for earnings growth in 2022 is currently at about 8%, coming off a record 2021. But that 8% has leveled out lately (even declining by some counts) and is seeing a growing risk of moving lower in the coming weeks as earnings season ramps up.
Those “early reporters” that have reported already are beating results by just 2.1%, less than half the 15-year average of 5.3% while the number beating expectations is at the lowest rate since the first quarter of 2020. We expect strong results to continue in the first quarter, albeit at a lower beat rate than prior quarters, continuing the streak since coming out of the pandemic, followed by a more uncertain second quarter and second half of the year as companies deal with more uncertainties including the war in Ukraine, higher inflation, higher interest rates, supply chain issues, and a shift in consumer’s spending from goods to services as the economy has just about fully reopened.
However, the focus will be on guidance. As with any other quarter, management’s guidance will be key and is expected to set the pace for the remainder of 2022. We have become accustomed to increasing guidance as the U.S. recovered from the pandemic, which has helped push stocks higher, but believe that trend will end with companies guiding more conservative due to the uncertainties mentioned above. We will be focused on the comments from management around input costs and margins. We believe growth and tech will continue to be under pressure as valuations come down due to higher long-term rates, while favoring large dividend paying equities and floating rate investments like senior loans.
Week in Review:
Stocks got off to a slow start, opening relatively unchanged, but steadily moved higher through the day last Monday to finish significantly higher. News over the weekend included China making additional moves to prevent desilting its stocks on U.S. exchanges, and Russia pulling back from several cities surrounding Kyiv and leaving evidence of war crimes behind leading to potentially more sanctions. The big news of the day was Elon Musk’s 9.2% stake in Twitter, a catalyst sending many tech stocks higher on the day. The NASDAQ was up 1.90% while S&P 500 gained 0.81%. Tuesday morning included several Fed speeches with Governor Brainard saying “of paramount importance” for the Fed now is getting inflation down while saying the Fed may announce a balance sheet runoff plan as soon as the May meeting and will be done so at a “rapid” pace and at a faster pace than last time, with the ability to do so more aggressively if needed. Bond yields, particularly on the long end, moved higher while stocks, driven by a large drawdown in growth, moved lower as balance sheet reduction will affect longer dated bond yields more than the shorter end. The 10-year yield rose 16 basis points to 2.56% with the NASDAQ and S&P 500 down 2.26% and 1.26%, respectively. The selloff continued into Wednesday as investors continued to digest Brainard’s comments and the more aggressive path of policy. In the afternoon the Fed meeting minutes were released that showed a possibly sooner and more aggressive quantitative tightening cycle. The Fed discussed reducing its balance sheet by $95 billion per month starting at its next meeting, in addition to a 50 basis point interest rate increase. The 10-year yield moved up to 2.66% on the news while stocks fell immediately after the release but finished off the lows with the S&P 500 down 0.97%. Also happening on the day was the Dow Jones Transportation average dropping into bear market territory (down 20%+), another common recession indicator. It was a more quiet day Thursday with markets opening lower but experiencing a late day rally, with defensive names continuing the trend for the week being the best performing stocks. The S&P 500 was up 0.43% while the NASDAQ was up just 0.06%. Markets ended the week with another uneventful day. The attack on civilians continued in Ukraine after Russia bombed a train station in Eastern Ukraine where citizens were fleeing the city, killing at least 30. Talks on additional sanctions continued all week. Stocks traded back and forth and closed mixed, the S&P 500 down 0.27% while growth and tech struggled again with the NASDAQ down 1.34%. Bonds saw another selloff for the week as the 10-year Treasury yield moved from 2.38% to 2.72%, while stocks were mostly lower and finished the week as follows: Dow -0.28%, S&P 500 -1.27%, NASDAQ -3.86%, and Russell 2000 -4.62%.
Recent Economic Data
- Data on trade in goods and services shows the U.S. trade deficit remained at $89.2 billion in February, matching January’s deficit for the largest monthly deficit the U.S. has ever seen. Exports of $228.6 billion rose 1.8% in the month while imports of $317.8 billion rose 1.3% in the month. Exports of goods and services were broad based, mostly driven by pharmaceutical and travel. Imports were driven by crude oil, other chemicals, and changes for the use of intellectual property, offset by a large decline in auto imports. Compared to a year ago the deficit is $21.7 billion larger. The “real” change, which is a direct input to GDP, is $15.8 billion more than a year ago, a detractor from GDP as the U.S. imported more than it exported, but reflects strength of the U.S. consumer due to the stronger recovery compared to the global economy.
- For the week ending April 2, there were 166,000 unemployment claims for the lowest level since 1968. The four-week average was 170,000, down 8,000 from the prior week and also a 54 year low. Continuing claims were 1.523 million, slightly higher from the week prior, with the four-week average at 1.541 million.
- The spinoff of WarnerMedia from AT&T was completed Monday. Existing AT&T shareholders received approximately 0.24 shares of Warner Bros Discovery for each share of AT&T held. Immediately after the spinoff, the WarnerMedia shares will be exchanged for stock representing approximately 71% of the new Warner Bros Discovery. Warner Bros Discovery will be trading under the new symbol “WBD”.
- Two months after Frontier Airlines made a $25.83/share offer to acquire Spirit Airlines, Jet Blue made an offer to buy the low cost carrier for $33/share, or $3.6 billion. A statement from Spirit said the board will work with financial and legal advisors to evaluate the bid and pursue what is in the best interest of shareholders.
- Warren Buffett’s conglomerate Berkshire Hathaway said it has taken a $4.2 billion stake in the printer hardware company HP Inc., or about 11.4% of the company. This comes after large investments in the insurer Alleghany and oil producer Occidental Petroleum.
- Carnival Cruise Line said the one-week period of March 28 to April 3 was its busiest booking week in the company’s history. The company saw double-digit increase from the previous 7-day record. It said it now has 22 of its 23 ships back in operations across all its year-round ports.
- Federal Reserve Governor Lael Brainard, typically one of the more dovish Fed members, said in a speech last Tuesday it is of “paramount” importance for the Fed to get inflation down, highlighting the Fed’s urgency to tighten policy by saying the Fed may look to reduce its balance sheet “at a rapid pace as soon as its May meeting” and a pace faster than in the previous recovery. Markets took this as more aggressive than what was expected. A more aggressive balance sheet runoff affects longer dated yields more than short-term yields as the Fed holds more longer-term bonds, and rolling those off reduces demand and increases supply, therefore prices go down and yields rise on these longer-term bonds. After the speech stocks moved lower on the comments, particularly growth stocks as they are most sensitive to longer-term rates.
- In its most recent outlook, Deutsche Bank became the first big bank to forecast a recession as soon as next year. The bank’s economists say its base case is the U.S. economy falling into a recession late 2023 with growth modestly below trend in the first half 2023 and the economy decelerating sharply in the second half as the Fed’s tightening hits the economy. It sees the 10-year Treasury yield rising to 3.3% this year, stocks falling 20% by summer 2023, and unemployment rising to 4.9% by 2024.
- Senator Joe Manchin (D-WV) said at an event he will not support an aggressive electric vehicle push due to its current reliance on foreign supply chains. Manchin’s two major reasons were because Biden’s proposals have not addressed who will get revenue from the electricity used to charge EVs with taxpayer funded charging stations, and made the point the mineral supply chains of the U.S. are underdeveloped.
- Chinese stocks listed in the U.S. saw a brief recovery last week after the China Securities Regulatory Commission posted on its website plans to revise confidentiality rules regarding overseas listings. Chinese stocks listed on U.S. exchanges have been under pressure lately over risk of being de-listed from U.S. exchanges over audit requirements. The proposed rule change would allow non-Chinese government agencies, including U.S. regulators, full access to Chinese company’s financials and audit reports. The relatively new U.S. law states foreign companies would be delisted unless they are in compliance with U.S. auditing disclosures for three straight years.
Did You Know…?
Stocks and Midterms:
Barron’s notes the six-month stretch before a midterm election has historically been the weakest six-month period in a presidential cycle. In addition, the worst of these years comes during the first term of Democratic presidents. This matches the “sell in May and go away” saying but is worse in midterm election years. According to Barron’s and the Stock Trader’s Almanac, during these years, going back to 1926, the S&P 500 returned just 2.2% during the May-October period. However, the subsequent six-month November to April period that stretches into a president’s third year is by far the best, averaging a 13.9% return.
Mortgage Costs Still Rising:
Those looking to buy a home in the current environment are seeing the cost of a mortgage rise at a very fast pace. The monthly cost of a mortgage is 38% higher than a year ago, according to Realtor.com. this is due to higher home prices and higher interest rates. Over the same period, demand for mortgages is down 41%. This should improve supply in the months ahead, but the sales pace will likely pull back as well.
Please keep in mind the U.S. stock and bond markets will be closed, along with Wentz Financial Group, on Friday April 15 for Good Friday. We understand the tax deadline on April 18 and there may be request for distributions. As such, please be aware the banks are closed Friday as well and we ask if there is a need, please reach out as soon as possible.
We wish everyone a Happy Easter!
The Week Ahead
It will be a holiday shortened week as the markets will be closed Friday for Good Friday. The week ahead will see a kickoff to first quarter earnings season. As usual, big banks will be the first to report with results coming from JP Morgan, Goldman Sachs, Citigroup, and Wells Fargo. Other notable reports include Bed Bath & Beyond, Fastenal, and Delta on Wednesday, and Rite Aid, Taiwan Semiconductor, and United Health on Thursday. On the economic calendar we will see several inflation readings including the consumer price index on Tuesday with the expectation of an 8.4% year-over-year increase in prices. We will also see the producer price index Wednesday and import and export prices on Thursday. Also on Thursday is an update on weekly jobless claims, March retail sales, where consensus sees another strong increase of 0.6%, along with consumer sentiment. Several Fed members will be talking to the public as well.