Equity View: Macro Musings on Earnings So Far

Summary

• Earnings have been mostly solid so far – no surprise there given near-full employment.
• Earnings confirm we are amid rolling recessions in specific sectors, affecting housing, semiconductors, and consumer-facing tech for now.
• Soft or even negative outlooks suggest gathering clouds on the horizon. Companies in the freight sector report demand for moving goods in coming months is already slowing.
• Some industrial companies are turning more cautious even as demand persists; others remain upbeat.

Market Implications

• We cannot confirm yet that the economy is headed for recession based on what companies are saying.
• Many may be managing expectations downward. But we suggest paying close attention to companies that are already seeing meaningfully soft demand.

Earnings Season: Noisy, But Still Revealing

Earnings season often presents a cacophony of information about where the broader economy is headed, and the current one is no exception. Here are a few observations.

Tech – Consumer vs Industry Divide Continues

• Companies exposed to consumer products are faring poorly. The latest victims are Microsoft (MSFT), as demand for PCs falls, and Alphabet (GOOG), as wary advertisers pull back. Texas Instruments (TXN) confirmed the chip slump is deepening.
• Stock of Corning Glassworks, maker of display screens for TVs, PCs, and phones, dropped 8% after reporting weaker-than-expected sales volume and guidance.
• On the other hand, Juniper Networks (JNPR), maker of internet plumbing, is thriving as many companies upgrade their technology to cope with worker shortages and transition to the cloud.
• This dichotomy between winners and losers, and optimism (up to now) about the major tech firms, has helped the NASDAQ 100 trade at more than 10% above our fair value measure even as the S&P 500 is near fair value. We look for some of that excess to leak.

Consumer Discretionary – Pick Your Spots!

• People are spending on experiences. Boyd Gaming Corp, with a portfolio of casinos and resorts, beat estimates.
• Motorcycles are selling well, according to Harley Davidson (HOG). It is benefitting from low inventories that keeps prices high, tight supplies of new and used cars, and people simply wanting to get out and have some fun.
• Spending on stuff for around the house is lower. Toymakers Mattel (MAT) and Hasbro (HAS) reported misses as inflation hits demand. More ominously, they are looking at a weak holiday season.

Consumer Staples – People Still Paying Up

• Many consumer staples companies – including PepsiCo (PEP), Coca-Cola (KO), Procter and Gamble (PG) – are reporting solid beats and affirming or raising outlooks. Restaurant chains such as McDonald’s (MCD) and Chipotle (CMG) also report they can raise prices and maintain good demand.
• But KO and PG also report seeing consumers start to shift to store brands or smaller packages. But so far, this has yet to morph into a broader trend.

Freight Warnings – Slower Demand Is Here

• Trucking and logistics companies JB Hunt Transportation (JBHT) and Knight-Swift Transportation Holdings (KNX) reported good beats – but also said they were seeing weaker demand for freight services in 4Q. Note – they aren’t saying macro headwinds could lead to softer demand – rather that demand is already slowing.
• Packaging manufacturers Crown Holdings (CCK) and Packaging Corp (PKG) had a similar message – demand for packaging materials is falling.
• Railroad Norfolk Southern (NSC) also reported declining intermodal (container) traffic. However, it posted a solid beat and affirmed its outlook because of higher commodity carloads – a consequence of lower shipments on the drought-stricken Mississippi.
• Many other companies are bracing for a slowdown but do not seem to see it yet in their business. Much of that could be managing expectations down. We suggest focusing on those companies that already see the slowdown.

Industrials – Are Clouds Forming?

• Fastenal (FAST), supplier of all kinds of fasteners and connectors to Corporate America, posted a solid beat. Demand is still strong but FAST offered conservative guidance, saying it was positioning for softer demand in coming months.
• Illinois Toolworks (ITW), which operates in a similar niche and also makes various adhesives products, is more upbeat. It raised its full year EPS guidance from $9.40-­9.45 to $9.55.
• It is questionable whether both can be right.
• Companies exposed to the housing and construction sector are doing poorly. These include appliance maker Whirlpool (WHR), and building products manufacturer Masco (MASCO).

The Bottom Line

It is shaping up to be a mostly solid earnings season even as some big misses pull down the aggregate EPS beat to 1.5% – about 4.5% has been the norm in recent quarters (Table 1). With the economy near full employment, there is no surprise there.

We can say that some sectors are already in recession, including semiconductors, consumer-oriented technology, and housing and related pockets of industrials.

Our read of outlooks so far suggests more companies are expressing caution even if business is still good, while plenty are also sticking with the status quo.  

A full-fledged recession is hardly a given yet. It may be we see more of a rolling recession where some sectors are weak while the overall economy manages to limp along. Much depends on whether employment remains robust as the Fed pushes rates higher.

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.)