Wentz Weekly: Q1 Earnings Season Turned Out Better Than Expected

Wentz Weekly Insights
Q1 Earnings Season Turned Out Better Than Expected

US equities finished the week lower last week, snapping a five week winning streak, despite another great weekly performance by Nvidia – the third largest U.S. publicly traded company. The stock was up another 3% last week as momentum continued from its earnings report two weeks ago. The company’s market capitalization of $2.800 trillion is now just roughly $150 billion away from Apple’s market cap of $2.950 trillion as of Monday morning, and just $260 billion off Microsoft’s, which is the largest in the U.S.

While the S&P 500 declined 0.51% and NASDAQ declined 1.10%, small caps outperformed for the week squeezing out a slight increase and the equally weighted S&P 500 (where all 500 companies in the index carry an equal weight) was unchanged, a rare outperformance this year for both.

Despite Nvidia’s continue outperformance, the remainder of the tech sector did not fare so well last week, particularly software. There were several tech companies that saw large declines – like Salesforce 14%, Dell 13%, Veeva System 15%, and UiPath 25% declines, after reporting earnings results that underwhelmed. There was a bit of good though – some outperformance came from apparel and retailers like VF Corp, Gap, Burlington, and Best Buy – many of the stocks that have gotten beaten up lately.

That was similar to how first quarter earnings season shaped out. Nearly all S&P 500 companies have reported first quarter financial results and the calculations show aggregate earnings for the quarter are 6.0% higher than the first quarter 2023, a much better growth rate than the 3.4% growth expected when the quarter started two months ago.

However it is the case that the earnings growth came from a small group of companies, but just so happens to be those companies that have seen the best performance. For example, the earnings growth rate of the top seven companies in the index (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, and Tesla) was nearly 50%, whereas the other 493 companies saw aggregate earnings declines of 2%.

Markets are optimistic as the gap is expected to close by the first quarter of this year. According to BoA Securities, in the fourth quarter, the Magnificent 7 companies are expected to grow earnings by 15%, while the remaining 493 are expected to grow 13%. This should bode well for small caps, an area of the market that looks attractive in our opinion.

Artificial Intelligence was the major theme this earnings season. Per FactSet, AI was mentioned in 199 earnings conference calls between March 15 and May 23, the highest number of mentions ever (by far), with some calls mentioning AI as much as 95 times (Facebook parent company Meta). Obviously, technology companies had the most mentions of AI, but it was also mentioned in all sectors as all industries are seeing use of the technology to boost productivity and efficiency.

As always, forward guidance was the bigger focus for investors. This quarter, roughly 270 companies issued guidance for the full fiscal year and 127 of those have issued negative guidance (earnings guidance/forecast that was below analysts’ expectation) and 142 have issued positive guidance. This is something we will continue to follow closely as markets are valued on future earnings.

While the S&P 500 only fell 0.5% with it being a quiet week from a headline perspective, there was more back and forth than the weekly performance suggests. Volatility increased about 25% to its highest level since the brief spike in mid-April.

There was a little bit of good news for both bulls and bears. The focus on the week was from a data perspective including Wednesday’s downward revision to first quarter economic growth in the GDP report due to a downward revision in consumer spending, the component that drives 70% of GDP growth. The other was the Fed’s favorite inflation data released Friday that was exactly as expected, which market participants cheered by sending stocks higher Friday.

However, it may have also been Treasury markets that drove some of the sentiment. The shorter end of the Treasury yield curve (government debt that has a short maturity) saw yields fall while the longer end (government debt that has a longer maturity) saw yields rise slightly, resulting in what we call a steepening of the yield curve. The 2-year Treasury yield fell 8 basis points to 4.88% while the 10-year yield rose 3 basis points to 4.50%.

The blame went on the recent auctioning of new Treasury securities. There were three new rounds of auctions and all disappointed with lower demand which led to over-supply concerns. The next item on the Treasury calendar is Thursday when the Treasury announces its next auctions.

The other events that will be in the spotlight this week is new data on the jobs market. The job openings data is released Tuesday and on Friday the DOL releases its monthly labor report where economists currently estimate 195,000 jobs were added in May, another strong month. Beyond that, investors are looking foward to the FOMC meeting next week and the update of policymakers’ economic and interest rate projections.

Recent Economic Data

• Case Shiller Home Price Index: Home prices in all 20 metro cities tracked in the Case Shiller home price index increased in the month of March with the overall index rising 1.3%, well above recent trend (but up 0.3% after seasonal adjustments), making another all time high in home prices. Looking at the 12-month change, the national average is +6.5% with San Diego still reporting the highest year-over-year increase with a 11.1% increase, followed by New York at +9.2%, and Cleveland at +8.8%. No cities saw a y/y decline, with the smallest increases seen in Denver at +2.1%, Portland at +2.2%, and Minneapolis at +3.3%.
• Consumer Confidence Survey: The consumer confidence index, measured by a survey compiled by the Conference Board, for May was 102.0, a surprise to the upside, comparing to the 95.3 expected and the 97.0 reported in April for the first improvement in three months. The index has bounced between 95 and 115 over the past two years. The present situations index increased 3 points to 143.1, driven by a strong labor market, while the expectations index rose 6 points to 74.6, although was below 80 for the fourth consecutive month which typically signals a recession ahead.
• Money Supply: Money supply in the US (which includes cash on hand, deposits at banks, money market balances) increased $25.8 billion in April, or about 0.1%, and now up 0.6% from a year ago. Money supply is up 35% since the pre-pandemic, a massive increase in a short time, but down about 4.0% from the peak April 2022, the largest increase in history and the largest decline since the Great Depression. The large increase has contributed to inflation but also strong economic growth, but the decline is expected to contribute to a slowdown.
• GDP (second estimate): GDP, one of the closely followed measures of overall economic growth, rose at a 1.3% annualized pace in the first quarter, according to the second estimate of Q1 GDP based on more complete source data, which is 0.3% slower than the first estimate indicated. The downward revision was due to downward revisions in consumer spending, inventory investments, government spending, and offset somewhat by increased revisions in business and residential investments.
• Jobless Claims: The number of unemployment claims filed the week ended May 25 was 219,000, up slightly from the prior week with the four-week average at 222,500. The number of continuing claims was 1.791 million, up slightly from the prior week and the four-week average up slightly to 1.786 million. Unemployment claims have been steady, and very low, since the beginning of the year.
• Personal income & outlays:
  • The PCE price index, which is the inflation reading that the Fed puts most weight on, increased 0.3% in April, and up 2.7% from a year ago which matches March’s increase. The core PCE price index, which excludes food and energy prices, rose 0.2% with the 12 month change at 2.8%, also matching March’s increase. One of the more important readings, “supercore” PCE and measures services only which is where the stickiest of inflation is occuring, rose 0.3% in April and still up 3.4% from a year ago.
  • Personal incomes rose 0.3% in the month as expected, slowing from a 0.5% increase in March, and up 5.1% from a year ago – still a pace higher than long-term trend. The wages and salaries component increased 0.2% in the month and up 5.3% from a year ago.
  • Disposable income (income after taxes) rose 0.2% and up 5.2% from a year ago.
  • Consumer spending rose 0.2% which is a little lower than expected and is due to a 0.2% decline in spending on goods, which was offset by a 0.4% increase in spending on services. This is a large slowdown from the 0.9% increase in March. Spending is up 6.2% from a year ago, slowing from the 7.1% rate in March. Goods spending is up 2.8% while services spending is up 7.6%.
  • The savings rate remained at 3.6%, a historically low savings rate and compared to the 10-year pre-pandemic average of about 7.5%.

Company News

• Apple Discount Drives Sales Growth: Apple shares moved higher last week after Bloomberg News reported iPhone shipments to China spiked about 52% in April after retail partners cut prices through deep discounts, which was previously reported.
• Lower Airline Profits: Many airlines shares were lower last week after several financial updates including American Airlines lowering its profit forecast for the second quarter, below its prior range and below analysts’ estimates as well as United reaffirming its profit forecast, but it was also below analysts estimates.
• Mega Energy M&A: ConocoPhillips confirmed it has agreement to acquire Marathon Oil in an all-stock transaction that values Marathon at $22.5 billion (including its $5.4 billion in debt). Marathon shareholders will receive 0.2550 shares of ConocoPhillips stock for each share of Marathon owned, representing a 14.7% premium to where shares traded prior to the announcement. Along with the announcement, ConocoPhillips said it would increase its dividend and repurchase more shares over the next three years.
• T-Mobile: T-Mobile said it will acquire nearly all of US Cellular’s wireless operations, one of the last remaining regional wireless carriers in the U.S., as well as about 30% of its spectrum assets for $4.4 billion including debt. The news follows a report recently that T-Mobile and Verizon were in talks for separate transactions that would split US Cellular.
• Aramco Sale: The Wall Street Journal reported Saudi Arabia is likely to announce plans to sell between $10 billion and $20 billion worth of stock of Aramco, its state owned oil company, as soon as this week. The report said the proceeds would alleviate near term financial pressure and help fund its mega projects. The size of the offering will depend on the interest of international investors. Aramco initially went public in 2019 and raised $29.4 billion in the world’s largest IPO, with Saudi Arabia currently owning about 82% of the company and its Public Investment Fund owning another 16%, while the other 2% is publicly held.
• Slowing AI Chip Export Licenses: Nvidia shares (and other semiconductors) moved lower late in the week after a Bloomberg report said US officials have slowed licenses that allow chipmakers like Nvidia to send large scale shipments of chips, including AI accelerators, to the Middle East. The report said the change is due to a national security review related to AI development in the area. The time is being used to better understand how the equipment is being used, who is using them, and how the facilities are secured.

Other News

• China’s New Investment Fund: China said it has established a $47.5 billion investment fund in effort to boost its semiconductor industry, the third round of a government backed financing pool. The investments come after US implemented export restrictions on advanced chips and equipment to China, which include the advanced chips that power artificial intelligence.
• ECB Ready to Cut: A European Central Bank official said that Eurozone inflation was falling in a sustained way and suggested that the ECB could begin its rate cut cycle at its next meeting (this week), with one saying the first rate cut at the next meeting is a “done deal”. In April, data showed Eurozone inflation held steady at 2.4% compared to a year ago, below 3.0% for the seventh consecutive month, however, the newest data for May that was released Friday showed inflation in the region increase to a 12-month rate of 2.6%, higher than expected. Despite this higher number, investors still expect European Central Bank policymakers to lower interest rates at its meeting this week.
• Trump Found Guilty: Former President Trump was found guilty last week by a Manhattan jury on all 34 felony counts. The charges were for falsifying business records relating to payments made for an NDA during the 2016 presidential campaign. Sentencing is scheduled for July 11, just four days prior to the start of the 2024 Republican National Convention. This will also come just shortly after this first scheduled debate between him and President Biden on June 27.

Did You Know…?

Big Capex

According to a note by Goldman Sachs, the ‘Magnificent 7’ stocks (which include Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, and Tesla, and account for nearly 30% weight in the S&P 500 index) are expected to spend $348 billion on capital expenditures and research & development this year. He adds that another way to look at it is these 7 companies reinvest 61% of their operating free cash flow back into capex and R&D, which is around three times as much as the other 493 companies in the S&P 500 combined.

WFG News

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