Weekly report / Monthly report / flash alert The Fed raises rates by 50 basis points … A 75-basis point hike isn’t on the table … checking in on the state of Q1 earnings Today, for the first time in 22 years, the Fed raised rates by 50 basis points. The rate hike pushes the federal funds rate to a range of 0.75%-1%. In live comments after the policy release, Fed Chair Jerome Powell said that additional 50-basis-point hikes are on the table at the next “couple of meetings.” Importantly, Powell said the risk of a 0.75% hike was not being considered by the committee. Meanwhile, current market pricing suggests the fed funds rate will rise to 3%-3.25% by year’s end, according to CME Group data. The central bank also announced it will reduce its $9 trillion balance sheet. From CNBC: The plan outlined Wednesday will see the balance sheet reduction happen in phases as the Fed will allow a capped level of proceeds from maturing bonds to roll off each month while reinvesting the rest. Starting June 1, the plan will see $30 billion of Treasurys and $17.5 billion on mortgage-backed securities roll off. After three months, the cap for Treasurys will increase to $60 billion and $35 billion for mortgages. In response, all three major stock indexes surged with the Nasdaq leading the way, up 3.2%. ADVERTISEMENT BREAKING NEWS: DIVERGENCE IS HERE For the first time in 14 years, a 1,000% divergence window is now open. Luke Lango and Louis Navellier just delivered their #1 recommendation. Watch now. | |
***Meanwhile, what are earnings revealing about the health of corporate America? The market has been watching several issues. Fed policy is at the top of the list. But there’s also inflation, the war in Europe and its impact on commodities prices, the lockdowns in China and its impact on supply chains, and, of course, earnings. Last Friday marked the halfway point of our current Q1 earnings season. And despite some headline misses (think Netflix, Amazon, and Google), earnings have largely been good. For added detail, let’s turn to FactSet, which is the go-to data analytics company used by the pros. From last Friday’s Earnings Insight (FactSet’s most recent update): Earnings Scorecard: For Q1 2022 (with 55% of S&P 500 companies reporting actual results), 80% of S&P 500 companies have reported a positive EPS surprise and 72% of S&P 500 companies have reported a positive revenue surprise. Earnings Growth: For Q1 2022, the blended earnings growth rate for the S&P 500 is 7.1%. If 7.1% is the actual growth rate for the quarter, it will mark the lowest earnings growth rate reported by the index since Q4 2020 (3.8%). Now, some readers will look at this and point out that despite a respectable number of positive surprises, there’s a slowdown in earnings growth. That’s true. But if we dig into that, there’s something fascinating happening. If you exclude Amazon’s big earnings miss, the average earnings growth rate for the entire S&P jumps from 7.1% to 10.1%. Bottom line, earnings are holding up well. We can largely interpret this as meaning that, despite inflationary pressures, most companies have been able to protect their margins – and, therefore, their earnings – by passing along higher costs to the consumer. ***So, should we put a bullish checkmark by “Q1 earnings” and expect it to support higher stock prices? Well, yes and no. As we just saw, the earnings themselves are largely good. But if we dig deeper, there are some cracks forming. First, of the companies reporting positive earnings surprises, the size of that surprise is far lower than in past years. Back to FactSet: In aggregate, companies are reporting earnings that are 3.4% above expectations. This surprise percentage is below the 1-year average (+14.1%), below the 5-year average (+8.9%), and below the 10-year average (6.5%). If 3.4% is the final percentage for the quarter, it will mark the lowest earnings surprise percentage reported by the index since Q1 2020 (+1.1%). We can interpret this as meaning that companies were topping analysts’ forecast by a wide margin…until now. Second, we’re seeing an increasing number of companies discussing the future with concern, referencing macroeconomic headwinds for the next few quarters. Again, from FactSet: During the earnings season for Q4 2021, 74% of S&P 500 companies cited “inflation” on their earnings calls from December 15 to March 14, while 74% of S&P 500 companies cited “supply chain” on their earnings calls from December 15 to March 14. These were the highest percentages of S&P 500 companies citing “inflation” and “supply chain” on earnings calls going back to at least 2010. There’s every reason to believe we’ll see similar or worse results this quarter. ADVERTISEMENT Crypto Millionaire: “Pay Attention to May 20” On Friday, May 20, a little-known, but HUGE announcement could make waves for crypto investors... Here’s what’s going on... | |
***So, how does all of this impact valuations, which impact stock prices? Obviously, this has been a painful year so far for stocks and bonds. Actually, let’s not breeze past that statement. This pain deserves greater context. It hasn’t just been a “painful” year; it’s been one of the five worst years out of the last 100. As you can see below from quantitative analyst Meb Faber, the losses here in 2022 from a traditional 60%/40% stocks-to-bonds portfolio are historic. Clearly this is bad news for your current portfolio value. But is this good news from a longer-term perspective? Specifically, has this decline served as a pressure valve release, taking air out of the super-high valuations? And if so, to what extent does it change the outlook for stocks from here? Let’s start with what FactSet is telling us about forward valuations: Valuation: The forward 12-month P/E ratio for the S&P 500 is 18.1. This P/E ratio is below the 5-year average (18.6) but above the 10-year average (16.9). Keep in mind, what’s being measured here is analysts’ expectations about where earnings will be in twelve months (relative to today’s price). So, that 18.1 forecast is based on guesses. But as we saw a moment ago, today’s positive earnings aren’t beating forecasts by nearly the same margin as they were in past quarters. And a vast majority of companies are giving a hat-tip to worse conditions looking forward. In light of this, might the 10-year average forward PE be a little more realistic to anchor onto? ***Let’s see what this might look like visually Below is a chart of the S&P’s forward 12-month earnings per share (EPS) (in black) compared with the S&P’s price (in blue) using FactSet’s data. The chart goes back to April of 2012. I’ve added two trendlines that reveal a tale of two time periods. There’s 2012 through 2022 – the 10-year forward EPS trendline in solid red. And then there’s 2017 through today – the five-year forward EPS trendline in dotted red. Here’s the chart, then we’ll analyze it more. As you can see, the slope of the five-year forward EPS trendline is noticeably steeper than that of the 10-year. Why? Well, much of it has to do with Covid and something called an earnings “pull forward.” ***Looking at earnings estimates and market potential through the eyes of the “pull forward” During Covid-19 lockdowns, many Americans were stuck at home, yet still receiving a paycheck – possibly also a stimulus check. With no ability to go out, yet income coming in, many Americans felt flush. Many shoppers splurged on various goods they otherwise may not have purchased. This “pulled forward” corporate earnings that, under normal circumstances, wouldn’t have accrued to companies during those quarters. And it wasn’t just big-ticket items. It was also small stuff. For example, remember the run on toilet paper during the height of Covid? That goosed earnings for toilet paper manufacturers/retailers. But it was artificial growth. When lockdowns ended, people had stockpiles of toilet paper at home. So, new toilet paper sales dropped off substantially when people just went to their closet instead of the store. This underscores the problem with pull-forward earnings: They don’t last. And eventually, there’s a hangover effect. From Mike Wilson, Morgan Stanley’s Chief U.S. Equity Strategist, being interviewed on Bloomberg: I think we’re going to be surprised how broad-based the pull-forward was… I don’t see how the pull-forward during Covid…(how there won’t) be a big payback. And when asked if this pull-forward effect would apply to stocks beyond the “stay home” stocks like Netflix and Zoom, here’s Wilson’s response: Yes, absolutely. It’s just the math. Just like the consumer goods companies saw spending well above trend, we saw the same thing in things like software and PC consumption, handset consumption, server consumption, cloud expansion. I mean, it’s all over the place. I think it would be naïve to suggest that they’re going to be immune to the payback in demand. Whether it’s corporate or consumer. ADVERTISEMENT Divergence Is Here – And Could Put Inflation Fears to Rest For the first time in 14 years, a 1,000% divergence window could turn market volatility into 1,000% gains potential. That’s why Luke Lango and Louis Navellier just hosted an emergency briefing to show how the power of divergence could put inflation fears to rest… permanently. Click here to watch it now. | |
***With this perspective, let’s return to our chart above, which we’ll show again here for convenience With an awareness of the pull-forward effect, here’s a question for you: Which forward EPS slope do you think is more likely to be accurate going forward? The 10-year solid-red trend line, which is generally “business as usual”? Or the more recent, steeper, five-year trend line that reflects pull-forward earnings? But before you answer that, now factor in the tighter monetary policy from the Fed. Not just today’s 50-basis-point hike, but the potential for a handful more of such half-point hikes going forward. My money is on the longer-term, solid red trendline. Here’s what FactSet is reporting about projected price increases over the next 12 months: The bottom-up target price for the S&P 500 is 5221.47, which is 21.8% above the closing price of 4287.50 Does that feel right to you? We’re running long so let’s wrap up for today. Tomorrow, we’ll pick back up our analysis by diving into the influences of inflation, Russia, China, and the U.S. employment/wage situation. But for now, let’s enjoy this rally from the market. Have a good evening, Jeff Remsburg |