Earnings Outlook: Oracle, Adobe Look Attractive as Equity Logjam Persists

Summary

• Equities remain mired in a narrow trading range that began in early July. The end of summer and hot weather season may bring little relief. 
• We see the logjam continuing until the economy breaks weaker and forces the Fed to choose between keeping the recovery going (i.e., easing) or damping inflation (i.e., higher for longer).  

• Companies continue to report robust results, but often disappointing outlooks, leading to selloffs. The latest examples are Oracle and Adobe, which sold off by 13% and 6%, respectively. 
• Between that pattern and still-rising 10Y Treasury yields, we expect modest downward pressure on indices. 
• Only five companies report next week, but they include Autozone, Fedex Corp and Darden Restaurants. All could provide key insights into emerging macro trends.  

Market Implications 

• We remain underweight the homebuilder ETF (XHB) and Russell 2000 ETF IWM due to the pressure of rising Treasury yields. 

• Both Oracle and Adobe are attractive investments after their respective selloffs; we think ORC offers better value. 

What We Learned Last Week 

Equity markets remain locked in narrow trading ranges, moving up and down by 1% or so on news flows. Early in the week, an acceptable inflation report and firm retail sales bolstered confidence in the economic outlook and the Fed staying on hold for now. Come Friday, sentiment softened as the 10-year Treasury rate exceeded 4.3% to settle at 4.33%. 

And so it goes. What might push markets out of the trading ranges that have persisted since early July (Chart 1)?  

It is mostly about the Fed – At the top of the list is a change in Fed stance – whether to adopt a Taylor Rule strategy and push rates sharply higher or signal coming cuts to keep the recovery going. (We expect neither.) A noticeable increase in unemployment or economic slowdown would spark a selloff (unless the Fed takes offsetting action). A clear resumption of earnings growth would spark a rally – as we noted recently, both trailing and projected earnings have essentially flatlined despite higher inflation. 

Until something happens, we expect equities to remain in this recent trading range. If anything, risks may be tilted slightly to the downside given our expectation that the 10Y Treasury yield is likely to rise to 4.5%. 

Earnings Rollcall – Earnings this past week give another reason to think markets are looking for reasons to sell off. Both Oracle (ORCL) and Adobe Inc (ADBE) reported solid beats on earnings and revenue. But they disappointed on outlooks. ORCL projected revenue growth of 5-7% next quarter; the market was looking for 8%. ORCL sold off by some 13%. ADBE offered an outlook in line with consensus; it sold off about 6%. We would say both companies were managing expectations downward to post nice beats next quarter, but markets were not in a forgiving mood.  

Both companies rallied strongly in June on strong earnings and lofty expectations about AI opportunities after Nvidia’s (NVDA) blockbuster results (Chart 2). Those expectations remain firmly in place, and neither company gave any indication to doubt them. Essentially, the selloffs were a modest unwinding of earlier expectations. 

Trades du Jour – Both ADBE and ORCL offer upside as the AI boom takes hold and moves to the next stage. ORCL offers better value at this point. Both ADBE and ORCL trade at relatively high trailing P/Es of 46 and 32, respectively; on a forward basis ADBE is 28.5 versus ORCL at 18.3.  

We continue to be underweight the homebuilder ETF XHB and Russell 2000 ETF IWM based on our expectation that the 10Y Treasury yield will rise to 4.5%. 

The Coming Week  

It will be another very light week for earnings, with only five companies in our Russell 1000 universe slated to report. But several will be of interest for parsing the macro outlook in coming months.  

Tuesday 

• Autoparts retailer Autozone (AZO) is a good barometer of consumer health. It tends to do better when consumers are under pressure, as tight finances bring out the DIY crowd – and more so-so when they are feeling more flush. 

Wednesday 

• Fedex Corp (FDX) has been contending with its own internal issues, but the big question for the economy (and consumer) is whether package volumes are still robust. 
• Are consumers still buying brand-name products from cereal and processed food maker General Mills (GIS)? 

Thursday 

• Darden Restaurants (DRI) will provide colour on whether the novelty of eating out is wearing thin as restaurant prices keep rising. 

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.)