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What keeps you up at night?
Ah, the fallback question.
Youâre a junior who just got their first job on Wall Street. You went out with your colleagues the night before, so youâre a bit hungover but you have to kill the dead air because the conversation with the management team has died down and the senior associate is just as hungover as you are.
So you hit âem with it.
âWhat keeps you up at night?â
While a saving grace of a plug-in to sound smart, I think this question might hold a lot of water when asking a group of leaders in these wild and wacky times.
Nearly every CEO has ârecessionâ on their nightmare list.
But this recession is a bit of a different beast. Instead of being a big bad obvious one like over the course of Covid⌠this one lurks in the shadows⌠waiting for its next unsuspecting victim.
Sure, some signs will show up in economic readings - manufacturing, retail sales, inflation, credit card data, used car sales, and so on and so onâŚ
But you never really feel the recession as a company or Fortune 500 employee until you absolutely whiff on earnings.
Itâs the quarterly confessional. It keeps us honest.
Financials have entered the booth, the verdict came out a bit mixed, and weâre going to have absolute mayhem come the end of the month when we get a double stack of megacap tech earnings + FOMC.
Weâll cross the FOMC bridge when we get there, but for this weekâs newsletter, letâs take a look at what to expect here over earnings.
This week, in <5 minutes, weâll cover earnings expectations over the coming quarter:
The Set Up đ Consensus = âEstimates Need to Come Downâ
Financials đ Economic Stalwarts Hit Some Turbulence
Health of the Consumer đ Savings Down
Energy đ Pumping Out More Cash than Oil
Technology đ The Red-Headed Step Kid
Letâs get started!
1. The Set Up đ Consensus = âEstimates Need to Come Downâ
Since lapping Covid-comps in Q2/21, we have been on a downward trajectory in YoY S&P earnings. Now, base rates are important. Companies got crushed back in 2020, then experienced rapid YoY growth over the recovery. Now, we are really starting to see the slowdown as normalization creeps in.
A big call on the Street across a lot of the talking heads is that âestimates need to come down.â But to me, it looks like they have come downâŚ
A lot of long/short funds have been caught offside by this massive YTD rally in ARKK 0.00 (which I talked about in last weekâs newsletter), meme stocks, and the unprofitable tech basket.
It seems the market did the exact thing that proved the most people wrong.
What is happening here is that a lot of the buy-side is working for the âlast cutâ before we see sustained long-only buying.
The big question will be - have we already seen the cut or is enough enough?
According to FactSet, the consensus for 22Q4 earnings growth is -3.9%. Earnings revisions have fallen on both a 1M and 3M basis, with the most recent cuts coming to Energy and Discretionary while Industrials and Real Estate have seen upgrades.
The average sell-side FY23 SPX EPS estimate is $210 (JPMe is $205). The recent macro data may put downward pressure on estimates and any rebound in yields may pressure multiples. Also, SPX margins tend to trend with CPI/PPI which leads to further concerns given the drop in PPI earlier in the week.
2. Financials đ Economic Stalwarts Hit Some Turbulence
When it comes to keeping a temperature gauge on the overall economy, analysts frequently look to financials to see whatâs going on.
Banks are at the intersection of two of the most important trends: rising rates and recession risks.
Rising rates are a net positive when it comes to net interest margins (NIMs) for major financial institutions. In a rising rate environment, the âspreadâ in the rate that the banks lend out at and the rate they borrow at widens. This improves overall margin profiles.
On the other hand, a recession indicates slower overall economic activity which decreases transaction volume at major banks as revenue lines can fall off in downturns.
Banks typically go first in earnings cycles and I think we saw a microcosm of what is going to happen in this earnings period - a divergence of names within industries. There will be hits and misses as the focus turns from macro to micro, making this earnings period a stock-pickers time to shine.
Last week, there was a stark difference in bank earnings on Tuesday when Goldman Sachs finished the day down 6.4% while Morgan Stanley ended the day with a 5.9% gain after both printing earnings.
As a recession threatens to derail transaction-based revenue like investment banking profit, the market is looking for banks that are focusing on other types of revenue sources. Goldman Sachs has not been so successful in diversifying into consumer banking and ended up posting its worst earnings miss in a decade.
Across the Street, Morgan Stanley was quick to show off the performance of its wealth management division, with margins approaching 30% and $6.6B in pretax profits for 2022. That led the bank's earnings to meet expectations, while its revenue total came in higher than the consensus.
Building in resiliencies through recurring revenue streams pays off.
Q4 reports the week before from the other banking giants also saw their stocks waver as they set aside billions of dollars in loan-loss provisions. Shares soon recovered after JPMorgan CEO Jamie Dimon projected a "mild recession," compared to his "economic hurricane" warning from last summer, while Bank of America and Citigroup echoed his views.
3. Health of the Consumer đ Savings Down
As goes the consumer, so goes the economy. Covid put a lot of stimmies in a lot of pockets as consumer savings skyrocketed, credit balances were paid down, and the overall health of the consumer was looking rosy.
Now the opposite is happening. Spending is strong but the source of spending has shifted. It is coming from decreasing savings balances and increasing credit balances as the overall wealth impact continues to erode.
There was one particular data point that actually shifted intraday price action in the market. As retail sales figures hit the tape, the rally was erased and reversed as fears over a weaker consumer emerged.
The outlook has turned more downbeat relative to consumer expectations from 3 months ago with savings coming in below earlier expectations, and less income growth now expected for 2023 as a whole.
Back in October, we thought that households would have about $300bn in excess savings remaining in 2Q this year. We now estimate that figure to be about $75bn.
With lower savings comes lower spending power which lowers the consumption of discretionary goods as spending shifts to essentials.
4. Energy đ Pumping Out More Cash than Oil
2022 was Oilâs year.
We realized how fragile our energy infrastructure is and how drastically weâve underbuilt it over the previous decades. What this has caused is Oil companies having absolutely massive free cash flow profiles.
A cool chart I also came across was this one.
It shows just how much FCF these companies are producing, so much so, that the FCF that theyâve produced in the last 12 months could acquire a lot of these green tech companies as legacy companies could look to diversify their energy profiles.
When it comes to earnings growth - energy has it in spades and is the leader of the pack.
With a lot of people focusing on a China reopening, the US focused on replenishing the SPR, and inventory deficits at historically high levels, itâs the right call to stay long energy.
IEA increased their 2023 oil demand estimates by 200,000 bpd and if they are near correct, oil prices should move higher. IEA is cautioning that supply will be ahead of demand in the near term but that should reverse in Q2. You should continue to want to own the oil-levered E&P stocks.
5. Technology đ The Red-Headed Step Kid
Technology was placed firmly in the doghouse over 2022 as it fought an uphill battle coming off of high growth rates and low profitability running face first into the interest rate hiking wall.
Within the subsector of technology, the software bucket is one of the âgrowthiestâ. The narrative here was that highly scalable, high gross margin recurring revenue proved to be a winning business model.
And this narrative was correct as software was eating the world.
However, while resilient to downturns, software is not bulletproof as productivity enhancers need production to optimize.
As global growth slows and the real economy retracts, so do spending budgets and while software may be one of the last components to get cut, it is not immune.
What weâve had as of late is slowing growth amongst the majors. One of the alarming stats that stuck out to me was just how much cloud growth is slowing. YoY growth amongst the majors is projected to slow from 35% in 2022 to 25% in 2023. We know what happens to slow growth in tech - death by multiple compression.
Salesforce is firmly in the doghouse. Microsoft announced cuts this week. Amazon is exposed to the slowdown in consumer spending and cloud slowdown. Apple has somehow come through unscathed from the bloodbath but something tells me the grim reaper is knocking. Meta will continue to have pains from Apple privacy changes and a slowdown in ad spend. Google will also be affected by the ad spend slowdown but also now a potential threat to its search monopoly in the MSFT/Open AI integration.
While the outlook is bleak, I would not be surprised if earnings come in âgood enoughâ, clear a low bar and we see some buying come back to the table. Short tech is too much of a consensus call and I think it wonât be as bad as people think.
If it ends up being the case that we already went through the earnings trough, tech multiples down here actually make it a value play and it should see a bid.
Wrapping UpâŚ
For the next couple of weeks, the most important thing shifts from CPI inflation prints to earnings. Sell-side analysts have a brutal period coming up, having to crank out reports on their 40-name coverage lists while asking questions on the calls.
The most important question will be - have numbers âcome down enough"? And, what does the forecast look like?
This could be a bottom-finding process on the earnings front.
But it wonât be peaceful, weâve got FOMC in early February, so buckle upâŚ
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S. Have you checked our ALTS and CRYPTO newsletters? Subscribe for free!
What else we Grittinâ On?
PPI. Producer prices fell more than expected in December. Prices fell 0.5% while consensus called for a 0.1% increase.
FREIGHT. Q1 is always the most difficult for freight carriers. But data suggest the US market is stabilizing.
WEB3. Despite slumping prices, developers were bus beneath the surface in 2022. Developer activity jumped 453%.
EXPECTATIONS. Analyst expect a recession ahead. They also expect record profit margins.
REITS. Investors seek to pull $20 billion from US core real estate funds. Bloomberg's gauge of publicly traded REITS fell 29% in 2022.
Sources:
https://www.cnn.com/2023/01/13/investing/bank-earnings-jpmorgan-chase/index.html
https://www.bloomberg.com/news/articles/2023-01-14/first-signs-of-recession-pain-look-set-to-emerge-from-earnings
https://www.bloomberg.com/news/articles/2022-10-25/big-oil-s-profits-just-keep-rolling-in-as-world-economy-sputters
https://www.reuters.com/markets/us/rebound-us-stocks-faces-earnings-test-2023-01-12/
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