Various earnings updates are flying in with fodder for both sides of the investment community. 19% of the S&P 500 companies have reported so far, with next week being the most important, as many mega-cap leaders announce results (Procter & Gamble, Coca-Cola, UPS, McDonald’s, Alphabet, Visa, Microsoft, Boeing, Meta, Honeywell, Amgen, and Amazon among many others). In total, 179 of the S&P 500 companies will report next week alone. As usual, most earnings are beating lowered guesstimates from Wall Street analysts, but at a lower rate than prior periods. So far, sales growth is on pace for a +2.2% expansion. However, inflationary impacts, higher labor costs, and loss of pricing power are leading to lower profit margins. Bottom-line earnings are expected to drop by 6.3%. Clearly, we are already in an earnings recession after Q4 saw similar declines.
Regional bank earnings took center stage this week. The results were pretty much what one would expect. Banks are putting more capital into reserves, providing a safety net for incoming defaults. When banks lend money, they typically put some cash aside to cover any potential risks involved. Most loans that occur during bull markets are expected to be paid back. When economic conditions worsen, reserves must be built up faster, all of which combines to make capital even less available to those seeking loans. Low credit score consumers/businesses are either shut out of the process or have to pay 10%+ to borrow.
On top of that, deposits, mostly at the smaller regional banks, are fleeing low-yielding products. Some have flown to the larger banks, some to 5% CD’s, some to 5% U.S. Treasuries, and some to money-market funds. All of this adds up to higher costs for banks, with lower deposit bases and less ability to make loans. Much of this is not new news, and should have been expected by many. Case in point, the Regional Banking Index has been stuck in a range since Silicon Valley blew up (see below). Holding those lows will be important as a base is built. It could take time and further proof that this is the only/last shoe to drop before those smaller bank stocks can rebound.
On the mega-cap side, bad news impacted Tesla, one of the major movers of market-cap-centric indices (S&P, Nasdaq), and it was not pretty. Tesla stock dropped ~10%, knocking off $50 billion of its market cap after earnings were unimpressive. Anyone following the company knows price cuts for their vehicles have been ongoing for a few months now. Elon Musk claims they do not care about pricing today as getting more and more vehicles on the streets is the game plan. Their long-term strategy is to turn every Tesla into an autonomous vehicle where owners can pay a software fee to let their vehicle drive around carrying passengers to any destination. Great idea, but how long before that becomes a reality? For now, Tesla sees increased competition as they are no longer the only game in town. Millions of battery-powered EV’s are in the market, with even more coming over the next few years. Competition is a beautiful thing for consumers but not corporate margins. Slowly but surely, Tesla is figuring out what Ford and General Motors have known for decades: building complex machines at sky-high margins is very difficult! Don’t feel bad for investors though, Tesla is still up 33% in 2023.
Below is a chart of the S&P 500 over the past year, then a brief discussion:
As Jim Meyer and I have been noting, the stock market has basically gone nowhere for the past year +, closing at levels similar to February 2022. However, a new uptrend is emerging, albeit on a shorter time frame. Ever since the lows set in October, the S&P 500 has been grinding higher (see the red upward trend lines above). This uptrend line has been consistent, with small corrections that make higher lows and higher highs. Chartists would note, this trend is to be followed until proven otherwise.
Everyone knows about the headwinds: inverted yield curve, valuations above historic norms, Fed tightening, declining money supply, lack of available loans, elevated inflation, and another market being led by fewer and fewer stocks. However, shouldn’t that already be priced in? If everyone knows those facts, what are the bears missing?
Let’s examine the bull case, as difficult as it is to be enthusiastic at the moment:
• Silicon Valley and Credit Suisse were major concerns, but banks have stabilized and stocks have simply shrugged off the news, reverting back to levels above the start of this crisis. A bullish response to negative news typically means the worst is behind us.
• Interest rates are dropping across the board. Those who missed out on 4% mortgages can now find sub 6% options today, as opposed to nearly 8% earlier in the year. On top of this, home building stocks are back near all-time highs. If housing can hang in there, why can’t the rest of the economy? Lower interest rates will help any recovery down the road.
• Wage inflation is in a new downtrend but employment remains full. A big concern for the Fed is rapidly rising wages keeping inflation elevated. A return to normalcy will help. Lower inflation and full employment are a dream-case scenario.
• Bank of America notes that their customers are still flush with cash.
• Oil prices spiked higher following a Saudi-led production cut. Today, crude oil has reversed all of those price gains. Even more important for Americans, gasoline inventories are rising. Prices at the pump could keep coming down, offsetting a lot of last year’s inflation.
• Artificial intelligence, improved software systems, cloud enhancements and continued innovation means productivity could finally be entering a new upward phase.
• Semiconductor stocks are showing real strength. These are critical components for nearly all industries. Demand for semis usually means a recession is not nearby.
• Inflation has been in a downtrend for half a year. There is minimal doubt that inflation is heading in the right direction, and it is quite possible it starts to accelerate to the downside into the summer months.
• In two weeks, we could be seeing the last of this Federal Reserve interest rate hikes.
All in all, there are numerous ways this year could prove to be a fruitful one for equity investors. Most of all though, almost everyone is bearish. Consumer sentiment and market positioning are powerful items. Hedge Funds are extremely short this market. Those shorts have to be covered at some point. The fuel is there for a rally, although this is not one we recommend getting overly aggressive on.
The bearish talking points still carry more merit and we have a lot of headwinds down the road as the Fed’s 500bps in rate hikes cycle through the economy. Inflation is coming down, but so is growth! Still, there are positives that could prove these bears wrong at the exact moment their story seems so plausible. Taking everything into account, we’re right back to a range-bound, yet slightly positive market. Not too bad, but not time to give the all-clear.
James McAvoy turns 44 today. Tony Danza, 72. Andie MacDowell is now 65.
James Vogt, 610-260-2214