Earnings Outlook: Corporate America Is Banking On More Inflation!

Summary

• Equities may rally in the coming days, given the still-robust labour market and forthcoming Q4 earnings season. But markets remain vulnerable to bad news.
• In recent earnings reports, two food companies offered aggressive earnings forecasts, implying that they expect more inflation and an ability to pass on higher costs. If correct, that will test any Fed resolve to soon go on hold.
• Q4 earnings season kicks off on Friday the 13^th with a barrage from the major money centre banks. Delta Airlines may comment on consumer travel plans.

What We Learned Last Week

Equities moved sideways to modestly up last week as investors waited for Friday’s employment report and next week’s Consumer Price Index (CPI) read. The S&P 500 ended the week up 1.5%; the NASDAQ 100 gained 0.9%.

Between a still-robust labour market, hopes that the Fed will soon be on hold, and the forthcoming Q4 earnings season, equities may enjoy a slight tailwind in the coming days – or until some negative news arrives.

We continue to be underweight equities in our asset allocation framework. We expect equities to remain in the trading range of the past six months until inflation is clearly on the wane – or the Fed takes further steps to slow the economy.

There were only a few earnings reports last week, but they were revealing. Two large food companies – Conagra Brands (CAG) and frozen potato products producer Lamb Weston (LW) – reported large revenue and earnings per share (EPS) beats  and meaningful volume declines.

Both said they managed their price/mix to maximise revenue gain. More significantly, CAG boosted next year’s EPS growth to 10%–15% versus 1%–5%. LW increased its full-year EPS to $3.75–$4.00 versus an estimated $2.97.

These companies will only achieve these targets if inflation is high enough to support those price increases and consumers swallow them. Clearly, some companies are bullish on both inflation and the economy, whatever the Fed may say or do.

On the industrial side, metals product manufacturer MSC Industrial Direct Co. (MSM) reported a modest revenue and earnings beat but missed on gross margin, suggesting it has been unable to pass on higher costs. Specialty chemicals manufacturer RPM International (RPM) missed on revenue and earnings and said that demand from the construction and home building sectors was soft.

Continuing a pattern we noted last week, no company mentioned concerns about a possible recession in 2023. We think most companies are so focused on the next quarter or two that they do not see a recession coming in that timeframe. Or perhaps companies are simply more bullish about the economy in 2023 than equity markets.

The Week Ahead

When Q4 earnings season opens next week on Friday the 13^th (of all days), more companies may discuss their full-year outlooks, and we may hear more about recession risk.

Some 14 companies are slated to report next week, with most of them financials.

Tuesday

Grocer Albertsons Co. (ACI) earnings will be of interest, primarily for news on its proposed merger with fellow grocer Kroger Co. (KR).

Friday

Many of the major banks report today, including Bank of America (BAC), Citigroup (C), JP Morgan Chase (JPM), and Wells Fargo (WFC). Of particular interest will be if loan loss provisions are rising (due to recession risks), loan demand, and capital market operations considering the choppy market conditions.

One key issue for asset manager Blackrock (BLK) will be whether it is stemming a loss of assets from conservative states and investors unhappy with its alleged policy of boycotting fossil fuel companies.

Delta Airlines (DAL) may report on its outlook for air travel in 2023 and whether it is benefiting from the recent decline in oil prices.

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.

(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.)