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Daily Capital

Markets: High Expectations on Earnings

Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.

Week in Review

January 3– 9

Want a sure-fire cure for inflation? Just stop buying stuff.

That seemed to be the message from last week’s economic data: inflation is off-the-charts high, but “relief” could be in sight in the form of lower overall consumer spending. Sales at the retail level declined -1.9%, with notable drops in all the categories that made living with the pandemic a little more bearable: electronics, sporting goods, musical instruments, furniture and all sorts of other stuff declined significantly.[1] Even the standard-bearer for strong pandemic-related demand – non-store retailers (think “Amazon”) – was down almost 9% in December.

By the way, care to take a shot at naming one of the few categories to score a rare increase last month? Health and personal care retailers. If you’ve been to a Walgreens anytime over the last several weeks, you’ll understand why: stores are crowded beyond the limits of even the most loosely-enforced social distancing rules, but COVID test kits are on backorder just about everywhere. Thanks, Omicron.

But when you think about it, this all makes it seem like December represented little more than a reckoning of sorts: after months of splurging on stuff to make us feel better during our COVID-mandated shut-ins, we all became a lot less spendy last month. (It’s probably no coincidence that pandemic-related relief is waning, too.) That, together with lots of anecdotal evidence that America’s parents rushed their holiday spending ahead by a few weeks out of fear that all those must-have presents for 2021 would continue to languish in cargo containers off the coast of Long Beach, gave last month’s disappointing retail sales figure an air of inevitability.

You might therefore be tempted to think that a big slowdown in consumer spending was both obvious and predictable, and you’d be right…unless you happen to be an economist. As a group, those economists silly enough to try to predict such things in a public and/or published format got it wrong by a wide margin: collectively, they thought retail sales would hold basically flat, meaning that last Friday’s report once again left them with a whole bunch of egg on their faces. (Eggs, by the way, are 11.1% more expensive now that they were this time last year[2]. More about that in a minute. But in the meantime, don’t go scraping any off the face of your local economist to try and save a buck or two – I know from experience that they hate that…)

It’s almost tautological that declining sales should eventually cause inflationary pressures to ease, and the case that some observers have been making that inflation would top out soon was made a little more credible by last week’s data. But for now, there’s still plenty of egg to go around for those who have been making that claim: prices at the producer level were 9.7% higher year-over year, while consumer prices were up 7.0%[3],[4] The last time the CPI was that high, the UK was at war in the Falkland Islands and Michael Jackson’s Thriller was in post-production. (For the record, that was 1982 – a year that I’m sure at least some of you don’t remember at all.)

And all of this is not lost on consumers. The University of Michigan’s preliminary look at consumer sentiment for January was almost as disappointing as December’s retail sales report (and nearly as exceptional as last week’s inflation numbers.) While you don’t have to go back to the early 1980s to find an example of data as weak as Friday’s UofM survey, you do have to scan back a whole decade, to 2012[5]. Notably, that means consumer sentiment is lower today than at any point during the pandemic, and as usual, Omicron and inflation get the blame. Accordingly, the good folks at the UofM spent a ton of time explaining how regressive inflation is (that is, it hits families in lower income brackets harder than those in higher income brackets.) As evidence, this month’s decline in sentiment was driven entirely by households earning less than $100,000 per year; families making more than that actually felt significantly better about their financial futures in last week’s reports.

Read More: 2022 Wealth & Wellness Index

That likely caught the Fed’s attention given that the central bank seems to worry a lot more about income inequality these days than it has in the past. It’s perhaps less-than-surprising, then, that the Fed’s pivot from front-line provider of massive accommodation to inflation-fighter extraordinaire continued to gain pace last week. Chairman Powell’s re-nomination hearing was dominated by a discussion of inflation and he came off sounding decidedly hawkish, as did San Francisco Fed President Mary Daly and Philadelphia’s Patrick Harker in separate comments they made during the week. Even Vice-Chair Nominee Lael Brainard, who was seen by some as an appeasement candidate designed to appeal to those who opposed Powell as too hawkish, came off sounding concerned when she identified inflation as the Fed’s Job #1 in 2022[6]. It’s easy to imagine, then, that the weak retail sales report might have been met with some quiet cheers inside the Federal Reserve – especially if it means that the demand environment is cooling enough to potentially take prices off the boil.

But let’s hope that doesn’t become a case of the cure being worse than the disease: while markets are quite familiar with (and perhaps even comfortable with) the risks implied by inflation, they seem far less attuned to a broader and perhaps more meaningful slowdown in aggregate demand that same inflation might help create (refer back to the paragraph discussing the University of Michigan’s sentiment report if you’re not seeing the connection…) If nothing else, this entire exercise shows exactly how hard it is for an economy to thread the needle between steady, predictable performance and the old-fashioned boom-and-bust cycles that have been so capable of upsetting markets in the past.

But for now, markets don’t seem too concerned – at least not equity markets, anyway. While last week certainly felt a lot less settled than we’ve become used to, stocks markets really didn’t perform all that poorly last week when you consider all the cross-currents they’ve been subjected to recently. Longer-term yields, too, were fairly well-behaved – at least when held up alongside the previous week’s drubbing that saw 10-year US treasury yields spike by 0.25%. That said, 2-year yields continued their dramatic rise as investors re-priced what a more aggressive Fed might men for rates, and Friday saw big moves across the whole spectrum of rates that seems likely to catch the market’s attention when everything reopens for business on Tuesday.

Finally, a quick comment on earnings. As we wrote about last week, this could shape up to be the most consequential earnings season of the entire pandemic. That’s because market expectations are high (and so too so are valuations, which places even more pressure on companies to deliver.) At the same time, though, there are plenty of unanswered questions about whether or not supply chains are truly healing, or whether cost burdens are really relenting, or whether last week’s disappointing retail numbers are really just an example of demand being pulled forward, or something more persistent (and therefore malignant.) Unfortunately, the small handful of big-bank earnings reports we got last week didn’t shed too much light on any of these questions: while the tendency to exceed analysts’ forecasts was almost unanimous, save for one glimmer of hope within Wells Fargo’s report, there was very little to suggest a consistent answer to any of the questions poised above[7]. So for now, I guess we’ll just have to wait and see.

What to Watch This Week

January 17– 24

Notable economic events (January 18-21)

Monday: US markets closed for Martin Luther King Day

Tuesday: Empire St. Mfgr., NAHB Housing Market Index; Earnings: GS, BK, JBHT

Wednesday: Housing Starts/Permits; Earnings: BAC, MS, PG, UAL

Thursday: Weekly jobless claims, Philly Fed, existing home sales; Earnings: NFLX, AAL, CSX, UNP

Friday: Leading economic indicators

Earnings season will start to gather more momentum this week.  As is always the case, the peak in the number of companies reporting is still weeks away, but some of the most impactful companies that provide the best read-through into what’s truly going on inside the economy are front-loaded into the early weeks of the season. This week’s main events will be a continuation of last week’s bank earnings (with Goldman Sachs and Bank of New York reporting on Tuesday and Morgan Stanley and Bank of America reporting on Wednesday.) Hopefully, this week’s bank reports will contain a little more insight than last week’s, which were really sort of a mixed bag.

For a view into what’s happening in the “real” economy, trucking company JBHunt reports on Tuesday, followed by a pair of rail operators (CSX and Union Pacific) on Thursday. Earnings trends and market color from transportation-related firms are always a great source of material for the macro-inclined, but it wouldn’t be much of an exaggeration to say that they’re the headline act of this earnings season. Look for these firms to provide context around all the supply chain bottlenecks that have plagued the COVID economy, as well as hope for their eventual resolution in the near future. A failure to deliver on either of those promises will almost certainly catch the market’s attention.

For a more direct read on costs, Procter & Gamble will report results on Wednesday. Margins are famously thin for consumer staples companies, meaning that costs can often play an outsized role in their earnings. The extent to which costs have represented a drag on companies like P&G will be an important read into exactly how big a bite inflation is taking into the corporate sector, while any comments about future pricing could provide a hint into how much worse things might get for consumers before inflation truly relents.

Meanwhile, for those worried about Omicron, two of the world’s biggest airlines will also report this week: United on Wednesday and American on Thursday. While leisure and personal travel have shown signs of a post-COVID recovery, business travel has lagged. Look for both companies to comment on that – as well as the impact of labor issues and fuel prices – when they report this week, providing a more nuanced read into how the evolving pandemic is influencing consumer behavior.

Finally, for an early read on one of the growth-iest of growth companies, we’ll get our first FAANG this week when Netflix reports on Thursday. Glamorously expensive growth stocks have been hit even without any kind of real setback in earnings in recent weeks, which places perhaps even pressure on them to impress with earnings. While the real centers of gravity as far as FAANG earnings are concerned is still a week or two away, Netflix might be a decent preview of coming attractions as far as that’s concerned.

As for the economic calendar, the most interesting thing we get this week will be a pair of regional Fed manufacturing reports, Empire State on Tuesday and Philly Fed on Thursday. Look for any evidence that cost pressures are easing, that the demand environment is cooling (but not collapsing) and/or the ability of firms to pass on higher costs to their customers remains at least somewhat intact. The regional Feds are always a great source of forward-looking intelligence into trends occurring at the corporate level and often hint at what might lie ahead for the manufacturing PMIs in the near future.

Beyond that, we get a healthy dose of housing-related data this week, starting with the National Association of Home Builder’s housing market survey on Tuesday, followed by starts and permits data on Wednesday and existing home sales data on Thursday. Housing is and always will be a critical sector for the economy, but by now the narrative is very well-known: housing seems to be taking a breather as relentless pricing and inventories have finally started to keep would-be buyers at home. Add to that the potential for rising mortgage rates, and it seems likely that we’ll be talking less and less about housing data for a little while, unless things take a sudden and unexpected turn.

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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.

 

[1] https://www.census.gov/retail/marts/www/marts_current.pdf

[2] https://www.bls.gov/news.release/cpi.t02.htm

[3] https://www.bls.gov/news.release/pdf/ppi.pdf

[4] https://www.bls.gov/news.release/cpi.nr0.htm

[5] http://www.sca.isr.umich.edu/

[6] https://www.federalreserve.gov/newsevents/testimony/brainard20220113a.htm

[7] Zacks.com, Bloomberg, company reports

Thomas Nun, CFA, is a portfolio strategist for Great-West Investments.
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