15 January 2024 Equities | US

Equities and the MacroSphere: Economy Looks Good, So Far

By John Tierney

Summary

Only about a dozen companies have reported so far, but we already see a pattern – the underlying economy is resilient, but cost pressures are making it tough to make money.
Delta Airlines reported booming demand – but is having difficulty raising prices to cover higher fuel and labour costs.
Major banks say the consumer is in good shape and are looking for lower inflation and rate cuts – but also face more pressure on net interest margins and regulatory costs.
A bevy of regional banks report in the this week. We look for colour on regional economies and more evidence last spring’s banking crisis is truly over.
In the nonfinancial sector, Fastenal will report on industrial demand for critical parts and transport giant JB Hunt may indicate whether the freight recession has bottomed yet.

Market Implications

We expect a lot of colour about the economy this week, but we doubt there will be market-moving information.
Equities should therefore remain narrowly rangebound.

What We Learned Last Week

About a dozen companies have reported Q4 earnings so far. The good news is that most companies see the underlying economy and consumer as resilient. The bad news is that most of them are downbeat on their earnings outlooks.

Airlines – Famine During a Feast of Demand

We start with an industry everyone loves to hate – airlines! Delta Airlines (DAL) reported record travel volumes during the Thanksgiving and Christmas holidays, booming international travel, and solid bookings through spring break. Clearly consumers are still in a traveling mood.

The flip side is that DAL (and presumably most other airlines) are struggling with three issues. These are high fuel costs, rising labour costs and labour shortages, and lingering supply chain issues that have impeded the timely repair and maintenance of aircraft. Yet, despite soaring demand and tight supply, airlines find it difficult to raise prices.

The bottom line is that DAL cut its 2024 profit forecast from over $7/share to $6-7. DAL’s stock price dropped 9%, while the broader SPX was up 0.7%. Indeed, airline earnings remain well below pre-pandemic levels and apparently liftoff is nowhere near.

Good for the inflation outlook? We expect most other airlines will report robust demand, which augers well for the economy. And as long as they cannot (or will not) raise prices to cover higher costs, that will help the inflation situation.

Banks Like the Economic Outlook

The early days of earnings season are dominated by another industry everyone loves to hate – the banking sector. Several major banks (including JP Morgan Chase (JPM), Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) reported on Friday that consumer demand is strong and that they expect a soft landing. They generally expect the Federal Reserve to cut rates. Loan demand is growing slowly, but on the plus side, higher rates have not choked off loan growth. All these are positive for the economic outlook.

The banks are also starting to increase loan loss provisions because of rising financial pressures on many households, although they are nowhere near worrisome levels yet.

From an earnings standpoint, results were mixed. Citigroup reported a loss, largely because of restructuring costs related to Russia, Argentina, and divestitures. C reportedly plans to cut 20,000 jobs, or 10% of its workforce. But that will be spread out between now and 2026, so the impact on unemployment will be gradual. Further, many of those cuts will likely involve divesting rather than eliminating business lines, so many of those job losses will be gains for other companies. C’s problems are mostly specific to C – and date back to the financial conglomerate that Sandy Weill tried to create during the 1990s that proved unmanageable.

Other banks had earnings nicked by a total of $9bn in one-time charges to help recapitalise the Federal Deposit Insurance Corporation by a total $16.3bn after the failures of Silicon Valley Bank, Signature Bank, and Silvergate Bank in March 2023. Never mind that these banks helped cushion the crisis by absorbing deposits from weak banks and, in the case of JPM, buying a troubled First Republic Bank.

Not that we expect many people to have sympathy for the major banks.

What is truly depressing is that there has been no accountability from the regulatory community. For this banking crisis was its fault. Regulators have no excuse for failing to understand interest rate risk – not after the disastrous thrift crisis of the 1980s (an event well within living memory). That cost some $160bn to address – or about $410bn in 2024 dollars. On top of that, after the global financial crisis regulators received a cornucopia of new regulatory authority through the Dodd Frank legislation of 2010.

There is simply no way regulators should have allowed any bank to mismanage itself to the point of setting off a veritable national crisis – certainly not the kind of mismanagement that occurred here.

The banks did point to further upcoming regulatory changes that will hurt earnings in the short run – and will eventually almost surely lead to further bank crises. If regulators cannot be held accountable to learn the lessons of recent history or use their tools to manage clearly identifiable risks, we cannot expect more regulation to do the job.

The Week Ahead

This week is still primarily about financials – out of 34 expected earnings reports, three-quarters are financials and many of them are major regional banks, including PNC Financial, KeyCorp, Comerica, and Fifth Third Bank. These companies should give more granular views of how different regional economies are performing.

We also hear from several key bellwether nonfinancials.

Aluminium processer Alcoa (AA) may provide colour on demand from infrastructure projects and high-tech equipment.
Fastenal (FAST) provides small but critical fasteners to manufacturers across the industrial spectrum. If demand remains on the soft side that will be a negative for the 2024 economy.
Transport and logistics giant JB Hunt Transportation (JBHT) will provide an update on whether the ongoing freight recession has bottomed out yet.

Here are some key earnings reports by day: