Keeping up with Earnings and Macro
By TRG Advisors on January 23, 2023
Markets Following the (Volatile) Macro
Analysts on the street have turned from stock-selection and company expertise to being entirely macro-focused. The day-to-day headlines are following up and down macro news, leading to
constant shifts in outlook. This is exhausting and inefficient for investors to follow. While we closely analyze the macro data and it helps make investment decisions, we don’t change our course because of a single brush stroke within a Monet.
The most important factor in our analysis is company fundamentals, valuations, and our in-depth knowledge and experience gained over the past 30 years. While every year is different, our perspectives and company understandings are critical in our process.
We are certainly seeing pockets of weakness tied to the Fed – particularly within manufacturing and housing. Housing starts are down -22% y/y and building permits are down -30% y/y. We see some selective opportunity here given there is extremely negative sentiment in the marketplace. Industrial production was down -0.70% m/m in December but is higher +1.6% y/y. And yes, the data is slowing but we must keep in mind that the European and China economic data is in fact improving. Again, selective analysis is critical – but it is interesting that industrials have been a leading sector
year-to-date. Importantly, there is a bifurcation within industrial production; energy, utilities and certain equipment categories are much higher than last year and continue expanding, while most goods manufacturing categories are contracting and have recently moved below last year’s production levels.
Retail sales contracted for the second-consecutive month in December (-1.1% m/m), but retail sales are up +6% y/y. The consumer remains healthy, and it’s not so doom and gloom when you look at the bigger picture: higher wages, strong job opportunities and slowing inflationary pressures. Gasoline prices are down -16% from highs (along with other commodity prices) and mortgage pricing is down -13% from highs. We’re hearing this from companies too.
The consumer is healthy because the jobs market is strong – record-low 3.5% unemployment rate – and wages are higher (+6.5% y/y). Initial claims for unemployment continue to trend lower, recently reporting its lowest levels since September.
Chart 1: Wages Higher, Initial Claims Lower1
The slowdown in monthly spending is a consequence of higher interest rates and normalization, after a non-normal period of post-pandemic, pent-up expansion. As inflation continues to retreat, the consumer will continue to experience more relief. With the Fed still putting their foot on the gas when it comes to restrictive, higher interest rate policy, we expect the broad contraction in inflation to continue.
Key categories of consumer inflation have retreated, particularly gas prices, which represent 4% of consumer wallet share, are down roughly 30% from June peak. Service-related categories remain persistently elevated. Rent, which represent 33% of consumer wallet share, continues to rise (+7.6% y/y). Food, which represents 14% of consumer wallet share is still moving higher as well (+10.4% y/y).
In December, the aggregate “all CPI items less food and shelter” decreased -0.7% m/m and is up just +4.8% y/y. This represents over half of total CPI wallet share for consumers. As inflation broadly retreats, we’re closely watching how far the Fed is willing to go to bring down stickier components like rents and food, which are more heavily impacted by the supply-side and wages.
Chart 2: Broad Inflation Trending Lower2
Further, mortgage rates are down from their November peaks. The 30-year fixed rate is now 6.47%, compared to 7.35% in November. A weaker U.S. dollar (USD) currency supports U.S. sales abroad. USD futures have retreated from its peaks and is now -13% vs. the Euro and -16% vs. the Yen since peak October levels.
Maybe the pain was last year. While we’ll still experience volatility, markets might experience greener shoots in 2023. Companies are sharing this outlook as well.
Earnings Takeaways
We reviewed the financial services sector last week and the key themes from banks included benefits from higher interest rates, preparing for unknowns with rising provisions for loan losses, a trough environment for banking fees and deal closings, strength in trading, and consumer resilience. The bank earnings were solid and importantly capital levels remain strong. This is not the same situation as 2008’s financial crisis when the bank earnings and capital structures were at risk.
We’re beginning to hear from a wider variety of companies and sectors, in addition to financials with 13% of the S&P 500 having reported Q4 earnings.
Within industrials, J.B. Hunt (JBHT) gave us a first look into the freight industry. While JBHT missed EPS estimates, analysts described the report as “better-than-feared.” It was known that volumes would be lower, but the company offered positive sentiment around “loosening” labor markets and better equipment availability, momentum from improving rail service and solid intermodal results. JBHT also increased its dividend.
Proctor & Gamble (PG) reported that they expect consumer-product growth to continue, along with pricing in 2023. Volumes have suffered from higher pricing, and they continue to manage a challenging inflation environment, but organic growth was +5% y/y in Q4 even with weakness in China and currency headwinds. Bottlenecks are easing and supply chains are improving. PG anticipates margin expansion throughout the year from pricing and better productivity.
SLB (SLB) gave insight into the energy services industry. The company reported better-than-expected earnings and increased its dividend +43%. SLB is optimistic for 2023 with “a very strong foundation for outperformance,” generated by their Middle East, offshore, and North America markets. Putting this together, banks are sharing this optimism, but are also implementing a prudent approach, which is to prepare for the unknowns. Earnings continue in volumes throughout the next three weeks, and we’ll continue to learn more each day.
First Look at Q4 GDP on Thursday
The street is expecting +2% q/q growth in Q4, while the Atlanta Fed’s GDPNow forecasting model estimates +3.5% q/q growth in Q4. These estimates follow +3.2% q/q growth in Q3.
Chart 3: Historical GDP and Forward Projections3
This indicates slower growth and reflects consumer resilience despite the cost pressures. The consumer represents roughly 70% of the U.S. economy. We anticipate a high degree of scrutiny and headlines around the Q4 GDP release.
FOMC Meeting Next Week
Consensus for a 25 bps hike at next week’s FOMC meeting seems to be creating some division within the Fed, as it appears certain members still favor super-sized hikes to ensure inflation has broken and will continue its downward trend. Bloomberg’s survey of economists forecast only a 3% chance for a 50 bps hike. Following last week’s retail sales, Treasuries rallied yet still finished the week lower. The 3-month yield remains stubbornly high relative to other maturities with the 3-month/10-year spread reaching an all-time low of -131 bps last week (data dating back to 1993).
The Week Ahead
Earnings – Monday: BKR. Tuesday: DHI, GE, JNJ, RTX, VZ, UNP, HAL, MMM, PCAR, LMT, MSFT. Wednesday: BA, FCX, T, IBM, LRCX, NSC, TSLA. Thursday: DOW, AAL, ADM, MA, VLO, URI, LUV, INTC, V, SHW, ROK, MKC. Friday: AXP, LHX, CVX. Economics – Thursday: GDP (Q4). Friday: Core PCE (December).