Earnings Outlook: Companies Defy Investor Worries

Summary

• Earnings are coming in better than expected, and many companies are optimistic about the 2023 outlook.
• But equites have traded in a narrow range since April.
• This may partly reflect risks associated with the debt ceiling and uncertainty about inflation and Federal Reserve (Fed) policy. But the key factor may be that earnings growth appears to have stalled for 2023, if analysts’ projections are correct.
• We see growing risk that the regional banking system could be headed for a catharsis like the thrift industry in the 1980s. We currently see the KRE ETF as a technical trading vehicle rather than an investment.
• About 185 companies will report this week, with focus on media giants, including Walt Disney and The New York Times.

Most Companies Looking for Robust 2023

There is plenty for investors to worry about: The threat of a debt ceiling disaster, banks weakened by rising rates, a possible recession in the next few quarters, especially if a credit crunch takes hold, and uncertainty about inflation and Fed policy.

Equity markets are largely unfazed by all this. The S&P 500 (SPX) and NASDAQ 100 (NDX) have been trading in tight ranges around 4,100 and 13,000 since early April. Q1 earnings season has only provided more support for equities. About 75% of companies in the SPX and Russell 1000 (RIY) are posting earnings beats of 6.7%, with the NDX at 7%. Some of this is due to low expectations, and much of the rest likely reflects unexpectedly strong pricing power in the face of inflation.

And outlooks for 2023 are almost uniformly constructive, if not outright bullish. There is hardly any mention of recession risks, debt ceiling concerns or worries about banks or credit availability.

Why have equities not rallied more given this good news? One reason is that companies and investors are different entities.

A second reason is that from 30,000 feet, the earnings outlook is weaker (Chart 1). Over the past few quarters, SPX 12M trailing earnings have flatlined. Further, projected forward earnings suggest little prospect of a resurgence in earnings growth in coming quarters. In essence, corporate earnings moved far above trend during the pandemic and are now returning to trend. NDX shows a similar profile.

Between limited potential for earnings growth and (in our view) still rising rates, equities will have difficulty rallying beyond current levels. But, if the earnings tone is good and we avoid systemic disaster, such as a debt ceiling crisis, equities may find a floor near present levels for now.

Regional Bank Woes May Be Just Starting

We had thought regional banks were near the lows during April, but the further selloff last week proved us wrong (Chart 2). We are starting to see growing risk that the regional banking system could enter a crisis, like the thrift industry in the 1980s.

The thrifts were weakened by the extremely high rates of the early 1980s. Then came several policy errors and benign neglect that amounted to ‘If we do not look, it will go away.’ But thrifts never got a chance to recover.

We could be starting down that road again. The sharp rise in policy rates over the past year has weakened many banks. It is possible that inflation falls, the Fed cuts rates, and the industry recovers. But we think it is more likely that inflation remains sticky and the Fed has to raise rates further.

Meanwhile, bank managements and bank regulators have evinced no understanding of the nature of interest rate risk. Their approach so far seems to be either ‘We do not have a problem’ or ‘If we do not look, it will go away.’ There has been no discussion of policy alternatives to address the problem. The Fed’s latest communication was that a credit crunch does not seem to be happening.

If this banking crisis happens. it will differ in many ways from the thrift industry collapse. But it will be similar in one key respect – it will be a slow-motion train wreck.

During this process, regional banks will appear to be recovering at times and will likely rally. The key question will be whether banks fully recover or remain in a weakened state and vulnerable to another shock. For now, we see regionals and KRE (regional bank ETF) as technical trading opportunities.

The Week Ahead

About 135 companies in our Russell 1000 universe report next week, slightly fewer than over the past two weeks. We hear from several media companies, including Walt Disney (DIS), The New York Times (NYT), and News Corp (NWS). Of particular interest will be advertising volumes/revenue and the outlook for a recovery in advertising spend.

Monday

• Some of the more closely watched companies will be Dish Network (DISH), PayPal Holdings (PYPL), and Tyson Foods (TSN).

Tuesday

• AirBnB (ABNB) will likely report strong summer bookings.
• Rivian Automotive Inc. (RIVN) will indicate whether its struggles to launch an electric vehicle product line is bearing fruit.
• Under Armour (UAA) hopes that it benefits from the consumer turn to sporty fashion.

Wednesday

• The New York Times (NYT) was one of the few media companies to report growth in advertising last quarter – can it continue this streak?
• With this report, returning CEO Bob Igor will increasingly own DIS results going forward. For now, he must lay out his vision and plan for DIS.

Thursday

• News Corp (NWS) gives an update on its advertising activity, but most people will be watching for comments about the Dominion court case and Fox News’ record settlement.

 Friday

• Have a nice weekend!

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)