Fed Speak and Earnings Curb Investor Enthusiasm
February 20th, 2023
Falling bank profits, slowing tech growth, and mounting layoffs combined to deliver a weekly loss to investors. Coming into the year, Q4 2022’s earnings season was anticipated to be a rough one. Overall earnings for the S&P 500 were expected to decline -2.80%. Excluding the energy sector, the picture was even bleaker with earnings estimated to fall -7.20%. Tallying the initial earnings reports, the earnings season could be even worse given that only 62.50% of companies have managed to beat analysts’ downwardly revised estimates. That’s below the long-term average where 66% of companies typically beat. It wasn’t just earnings that put investors in a foul mood this week, however. Several Federal Reserve members disappointed markets by continuing to stress the Fed’s intent in maintaining a restrictive posture despite increasingly visible signs that inflation is abating. Following three days of declines, markets managed to rebound on Friday led by news from Big Tech, where Netflix announced better than expected subscriber growth and Google announced large layoffs to boost their bottom line. For the week, however, the S&P 500 gave back -0.66%.
The Terrible, Horrible, No Good Retail Report
It wasn’t a holly jolly shopping season for retailers after all as consumers reined in their spending on holiday gifts due to high prices. Retail sales dipped -1.10% in December while November’s sales were revised down to a -1.00% decline from a previously reported -0.60% drop. Declines were broad-based with department stores, furniture and home stores, autos, and online retailers posting the biggest declines during the month. Holiday get-togethers also failed to support restaurants and bars, who saw sales receipts drop -0.90%. The economy’s social and entertainment industries had proven resilient to higher prices throughout 2022 but now appear to be succumbing to the basic law of economics, where higher prices equal lower demand. The report did offer one silver lining, consumers got some relief at the pump. While perilous from a recession standpoint, the broadening in the decline in retail sales should give the Fed some relief that monetary policy is beginning to take effect on the root causes of inflation.
Inflationary Pressures Continue to Ease, Outlook Remains Uncertain
Wholesale prices, which measure what businesses pay for goods and services, fell -0.50% in December, beating estimates of a -0.10% decline. A sharp drop in the energy index, down -7.90% helped drive much of the month-to-month decline. Within the energy category, gasoline prices fell -13.40%. Year-over-year, wholesale prices were up 6.20%, their lowest annual level since March 2021 and down from their 10% annual increase in 2021. It was much the same story for consumer prices which were released last week. The December CPI index fell -0.10%. A -9.40% drop in gasoline prices drove much of the decline. Year-over-year, the CPI index rose 6.50%, down from November’s 7.10% and from the 9.10% peak in June 2022. However, core inflation, which excludes food and energy, rose 0.30% month-to-month in December, up slightly from November’s 0.20% rise. A 0.80% increase in the cost of shelter was a driving factor in the core’s move higher. Services inflation, which includes a wide range of services including haircuts, car repairs, education, and hospitality, rose 0.40% month-over-month. Annualizing that current run rate and core services inflation is still running at an uncomfortable 4.80%. The Fed has keyed in on services inflation as their bellwether for where inflation is headed, which, at these levels, means the Fed is not likely to change course on rates despite what markets are anticipating.
Final Thoughts
Coming into the week, the S&P 500 and Nasdaq were up 4% and 5.29% YTD, respectively, driven by optimism over slowing inflation and a belief that the Fed will soon pivot to a more accommodative posture. Increasingly, the data suggests that inflation is starting to be contained, evidence we saw this week not only directly in the CPI and PPI numbers, but also anecdotally in retail sales and existing home sales data. At the Davos World Economic Forum, the mood was somber but not entirely pessimistic over the chances of a global recession later this year. The feedback from business and political leaders was that they are preparing for the worst but still hoping for the best. CEOs, economists, and investors seemingly believe that we will skirt a recession with the consensus worst-case scenario being that the global economy incurs a short or shallow recession. This slowing – but not too slow – growth scenario is now being tested by the reality of earnings season, which is shaping up to be slightly worse than expected. At the same time, Fed officials continue to use their speaking appearances to reiterate their commitment to maintaining a restrictive policy which contrasts with the market’s own expectations. Agnes Belaisch of Barings Investment Institute summed it up best in her quote to the Wall Street Journal, stating “I just don’t see how the Fed could start cutting [rates] as soon as it stops hiking. I don’t see why markets consider this an option. It would have to be a huge recession, which the market isn’t pricing in either.” Agreed. It seems inevitable that investors will be disappointed either by the Fed refusing to shift or by a recession causing earnings to erode more than expected – possibilities that investors took notice of this week.
The Week Ahead
Recent economic reports have pointed to slowing demand. We’ll see if the trend continues as we get our first read of Q4 2022 GDP. And after a weak holiday shopping season, traders will turn to December personal income and spending figures to determine how much gas remains in the tank for consumers to spend in 2023.
Paying it Forward
Probity Advisors, Inc. recently caught up with one of our former summer interns to talk about his career and life after graduating from college.
Mikial Onu was one of Probity’s first interns as part of the Life After Ball (LAB) program at Southern Methodist University (SMU). The SMU LAB program was created to help college athletes gain real-world skills and experience and facilitate a transition into a career after graduation.
As a college football player, Mikial was named a member of the American Athletic Conference All-Academic Team and led the Mustangs in tackles his sophomore season. He had dreams of going into the NFL draft, but a devastating injury in the fall of his senior season left him undrafted and redefining his future prospects.
Mikial was working in insurance and had begun to invest in real estate when he found a piece of land outside of Houston that he believed presented a great development opportunity. He wrote a business plan, including an operating strategy and an exit strategy, and found investors who shared his vision for economic development in an underserved and marginalized community. Mikial decided to focus on real estate full time and founded Onu Ventures where he currently serves as President and CEO. His company specializes in the development of urban areas serving underrepresented communities. Mikial’s latest project includes a mixed-use development in South Dallas that will provide workforce housing and bring infrastructure to an area that has historically been lacking, creating a vibrant community for growing families and young professionals.
Mikial credits his internship at Probity with teaching him how to conduct himself in a professional environment and how to communicate with colleagues and business leaders, listen to people, and solve challenges. He shared that Buddy Ozanne, Probity’s founder and president, remains part of his mentor network. Mikial’s goal is to grow as a leader and as a business owner and to help others along the way while also making a positive impact on the community. Mikial recently paid it forward by hiring an intern, Darius McBride, from SMU’s LAB program, and the two were featured in a video that you can view here, and you can read an article featuring Mikial and the incredible work he is doing from the Dallas Morning News here.