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- With the S&P 500 down 4.8% last week, the implied discount rate on future earnings bumped up by 50bp.
- We expect more companies to follow FedEx and report sharply lower outlooks for the remainder of the year. In short, weakness in Asian and Europe is a significant, growing headwind.
- Only 10 companies report earnings in the coming week, but they are an interesting mix of consumer-oriented bellwethers, including AutoZone, Costco, homebuilder Lennar, and cruise ship operator Carnival Corp.
- As more companies downgrade their outlooks, we expect forward earnings expectations will fall, putting further downward pressure on equities.
What We Learned Last Week
The S&P 500 was down 4.8% last week on the double whammy of a higher CPI report on Tuesday and then an unexpectedly weak outlook from FedEx (FDX) on Friday. The trailing and forward P/E ratio dropped nearly a full point, to 18.9 and 17.1, respectively. That effectively raises the discount rate on future earnings by about 50bp.
FDX projected EPS of $3.44 for the coming quarter versus consensus $5.10 – a 33% drop. The company pointed to macro headwinds and weakness in Asia and Europe. Granted, two thirds or more of its problems are self-inflicted. But still, it was rather like the boy who declared the emperor had no clothes.
For weeks, we have been hearing companies mention growing macro headwinds and the strong dollar as possible issues. Meanwhile, they were posting solid beats and not downgrading outlooks significantly. But no one quantified the risk, and investors seemed content to assume these problems were still somewhere over the horizon.
Now, however, markets are waking up to the emperor’s lack of apparel. And we expect more companies – especially those dependent on foreign earnings business – will announce weaker outlooks in coming weeks. Some of this, of course, will be the usual managing expectations downward. But the underlying message will be that those headwinds are starting to make a difference – for the worse.
This should lead to lower expectations for forward earnings and keep downward pressure on equities. We continue to be underweight equities in our overall asset allocation framework.
The Week Ahead
Only 10 companies in our Russell 1000 universe are scheduled to report earnings next week, but they are an interesting mix of consumer-oriented bellwethers.
- Homebuilder Lennar will likely offer a grim message on the housing industry. Look for whether it plans to tilt more toward rental housing construction as new homes move out of reach for many people.
- Superstore Costco Wholesale Corp (COST) will surely report robust business. Key questions will be whether it can pass on rising costs to consumers, and the extent to which consumers are substituting off-brand products for name-brand products.
- Darden Restaurants (DRI) will be another read on consumer sentiment. Retail sales data suggests demand for eating out has been heavy despite inflation as people put Covid restrictions behind them. DRI may provide insight into whether that continues in coming months.
- Financial data vendor Factset Research (FDS) counts the large investment banks as key clients. It will likely shed light on how much investment banking activity has dried up.
- Carnival Corp (CCL), another consumer sentiment bellwether, offers one of the more discretionary services out there. Are people sticking with plans to take a cruise or are cancelations mounting?
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.)
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