06 March 2023 Equities | US

Earnings Outlook: Investors Are Listening to the Fed, But Very Selectively

Summary

Equities were selling off until Thursday, when Atlanta Federal Reserve President Bostic called for a 25bp rates hike.
Several Federal Open Market Committee (FOMC) members have warned that rates will rise unless inflation abates soon.
Retailers are sounding the alarm about flagging demand from lower income consumers.
We expect equities to continue trading in the range of the past nine months. But between recent Fedspeak and ongoing soft outlooks from companies, we see downside risks.
Only 19 companies report next week, but they include several bellwethers, such as Oracle, Dick’s Sporting Goods and Campbell Soups.

What We Learned Last Week

Last week’s big takeaway is that markets continue to latch onto any optimistic news about the outlook for the economy and equities.

Early in the week, the S&P 500 (SPX) sold off, dropping 0.4% on soft PMI data, a 10bp rise in the 2-year Treasury (to 4.88%) and some weak earnings. On Thursday the tide turned as the SPX rallied 5% from Wednesday’s low. The NASDAQ 100 (NDX) rose 3%.

The catalyst was Atlanta Fed President Raphael Bostic, who said that he thinks the Federal Reserve (Fed) should raise rates 25bp, rather than 50bp, at its next meeting. Never mind that he also called for no rate cuts this year. Never mind his further comment that the Fed should continue raising rates if incoming data justifies it. And never mind that Bostic is not a voting member of the FOMC.

Never mind that Mary Daly, president of the San Francisco Fed (and also a non-voting FOMC member) called for higher rates for longer.

Never mind that Christopher Waller, member of the Fed’s Board of Governors and voting FOMC, called for higher rates unless inflation falls rapidly.

Never mind that Fed Chair Jerome Powell reportedly plans to testify to Congress about the possibility of more rate hikes, not fewer.

All these hawkish statements came within a day of Bostic’s comments. We concede that they were couched in terms of ‘if inflation does not decline soon’. But it is remarkable to twist that qualifier into a conviction that the Fed will be dovish sooner and for longer. Or maybe investors really believe inflation will be well below 3% by the end of 2023. They may be right – but for that to happen the economy will almost certainly have to be in deep recession – the kind where earnings and equities collapse. Be careful what you wish for.

The other big source of support for equities – earnings – remain mixed. In tech, several companies reported better-than-expected earnings but soft outlooks, including Dell Technologies (DELL) and SnowFlake (SNOW). Hewlett Packard Enterprises (HPE) was an outlier, with strong earnings and a robust outlook.

In retail, while many earnings beat soft expectations, outlooks were dismal. Discounter Ross Stores (ROST) expects flat sales in the year ahead. Kohl’s (KSS) expects a 2-4% decline. Best Buy (BBY) forecasts a 3-6% decline. Dollar Tree (DLTR) expects a low-to-mid single digit increase, but counts on an influx of higher-income customers ‘trading down’ to its lower-cost offering. These forecast declines are remarkable and difficult to believe given ongoing inflation. Even allowing for retailers managing expectations lower, the common theme across all these retailers is reduced spending on discretionary items by lower income households.

Try as we might to justify the bullish case here, we cannot. We continue to expect equities to trade in the range that has prevailed since mid-2022 – or 3600-4300 for SPX, until a catalyst pushes it out. We see downside risks, but it may be months before that scenario plays out (if it does).

The Week Ahead

Only 19 companies in our Russell 1000 universe will report earnings this week. These include several bellwethers that may shape opinions.

Tuesday

If Casey’s Convenience Stores (CASY), which sells gas, sundry grocery and health products, reports a soft outlook or is worried about the consumer, we can assume things are bad for many people.
Given the desire for recreation, Dick’s Sporting Goods (DKS) is one consumer discretionary retailer that might report a positive outlook.
Thor Industries, manufacturer of RVs, faces consumers that want to travel and avoid large ticket purchases. What will it be?

Wednesday

Will Campbell Soup Company (CPB) follow some other large food companies and try to hold the line on raising prices this year?
Brown-Forman (BF/A) may indicate how inflation is affecting demand for popular alcoholic beverages.

Thursday

On the tech outlook, Oracle Corporation (ORCL) is a key indicator.
If Gap (GPS) is having difficulties, part of this will likely be missing what consumers want to wear.
BJ’s Wholesale Club (BJ) sells a wide range of furnishings, electronics, and consumer products, which it may find that consumers are not buying.
Investors will hope Vail Resorts collection of destination resorts are in demand this year.