Earnings Outlook: Major Retailers Open the Books

Summary

• The incoming data points to both boom times and recession conditions – little wonder markets are stuck in narrow trading ranges!
• Regional banks keep selling off in a remarkably systemic fashion – markets have yet to discriminate meaningfully between stronger and weaker banks.
• We expect regional and consumer banks to suffer an extended period of stress, with an ultimate restructuring of the overall industry. We view the regional bank ETF as a trading rather than investment vehicle.
• Several major retailers report this week, including Target and Walmart. Have they been able to pass on rising costs to consumers?

What We Learned Last Week

I came across two interesting stats last week. First, there has never been a recession when earnings beats are as high as they have been for Q1 2023. Second, the economy has always been in recession when the word ‘recession’ appears in the media as often as it has recently.

They cannot both be right. But that the information flow seemingly points in both directions helps explain why equities indices have traded in narrow ranges since early April.

Here is our take on those stats.

Earnings Beats

The earnings beats are largely due to a combination of low expectations and analysts being clueless about the impact of inflation and the clear ability of many companies to pass on higher costs to their customers.

Another factor is that earnings are coming off an extraordinary surge in the 1.5 years after the election and are reverting to normal growth (Chart 1). Finally, any normal comparisons with prior periods are extraordinarily difficult given the move into, then out of, the pandemic economy. In short, those earnings beats mean little.

‘Recession’ in the Press

Regarding recession mentions, some of those articles have been about the so-called earnings recession. Depending on who is measuring, S&P 500 (SPX) and NASDAQ 100 (NDX) earnings have been flat or down 2-3% over the past year. The Fed is unconcerned about an earnings recession. It may well cheer one if it helped cool the broader economy.

Earnings recessions alone do not usually lead to major market selloffs. The typical scenario is that equities stall and trade in a well-defined range until earnings resume growing, like 2016-2018.

Going Forward

We expect earnings and equities to remain in a range for now. Given the Fed will likely be on hold indefinitely and may have to raise rates above 5.25%, we see little prospect of an economic or earnings surge that will drive a sustained rally. Meanwhile, there remains the risk of a major selloff if the Fed ends up engineering a significant recession or, heaven forbid, the debt ceiling situation is not resolved.

On the latter point, the likelihood of a debt ceiling crisis is small. Yet as former Treasury Secretary Robert Rubin in the Clinton administration argued, given that Congress keeps having these episodes suggests that the risk of an actual crisis rises over time. It is rather like the boy who cried wolf too many times – if the crisis never happens, people may expect it not to or discount the worst-case scenario.

We put little stock in news articles reporting that the two sides are having constructive discussions or are hopeful of resolving the impasse – this one will not be over until it is.

Regional Bank Gloom Deepens

Regional banks resumed their selloff last week (Chart 2). Particularly striking is how systemic the selloff is. Even two months after the Silicon Valley Bank crisis, regional banks are selling off across the board. We had expected markets would have sorted out which are the stronger and weaker banks by now and that there would be more discrimination in how their equities trade.

Clearly markets are looking for systemic factors that will drive bank earnings down. It could be higher capital requirements or significantly higher rates on deposits to compete with money market funds.

We increasingly think regional banks are in for an extended period of stress. Unless rates drop sharply, we expect the regional and community banking system to face a significant restructuring in coming years.

We view the KRE ETF as primarily a trading vehicle rather than a buy-and-hold investment.

The Week Ahead

The earnings flow slows to a trickle this week, with only about 35 companies in our Russell 1000 universe slated to report. But these include several major retailers, among them Target and Walmart. These companies will provide critical insights into both consumer demand and how they are managing inventories and supply chains.

Tuesday

• Home Depot (HD) may benefit from robust building activity as homebuyers turn to new construction due to a lack of existing home inventory.

Wednesday

• Target (TGT) will be the big news of the day.
• TJX (TJX) Companies will also be of interest, for consumer appetite for edgy fashion.
• On the tech side we will hear from networking giant Cisco Systems (CSCO); its take corporate CAPEX plans will be the primary focus.

Thursday

• Today is Walmart (WMT) day. Is its large grocery business pushing through the 8%-12% price increases that many other consumer staple companies have done recently?

Friday

• Deere & Co (DE) reports on demand for construction and farm machinery.

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.)