Author: J. Keith Buchanan, CFA, Senior Portfolio Manager
This week is one of turning points. Over the past several months, declining inflation data, negative earnings revisions, and anticipation of a decreasingly hawkish Fed has led to shifts in market sentiment to start the year.
Corporations continue to report fourth quarter results. According to our thinking, the market selloff of 2022 was the result of the forward-looking mechanism anticipating a recessionary environment and requisite earnings downturn. According to FactSet, at the end of last week, the fourth quarter earnings season is amounting to a 5% earnings decline compared to the same period of 2021. If this year-over-year decline holds throughout the earnings season, this quarter would mark the first decline since the third quarter of 2020, confirming at least some of the fears that the market priced in last year and reiterating that a turning point in corporate profitability is upon us. This week, over 100 S&P 500 companies report earnings, and we will undoubtedly gain much more clarity as to whether the market was correct in predicting an earnings slowdown and the magnitude of said slowdown before week’s end.
On Wednesday, the Federal Reserve’s Federal Open Market Committee will conclude its two-day meeting with a press release followed by a press conference in which Chairman Jerome Powell will give the statement and field questions. The fed funds futures market is pricing in a turning point of sorts in Fed action, even if the rhetoric remains the same. The market is pricing in a 25-basis point increase at this meeting, another 25-basis point increase at the March meeting, then standing pat before cutting rates in the fall. In other words, the market is betting that this is a turning point for the Fed where they stop becoming increasingly hawkish before turning dovish later this year. Any pushback against this consensus could be poorly received by risk markets.
The last potential turning point is this Friday when the Bureau of Labor Statistics releases its monthly nonfarm payrolls report. The consensus expectation is for the report to reveal that 185,000 jobs were created in the month of January. That level would be the lowest since December 2020 and second lowest since April 2020 when the labor market hemorrhaged 20 million jobs at the onset of the COVID pandemic. This report could, in essence, link corporate earnings and the Federal Reserve announcement earlier in the week. If the consensus expectation turns out to be correct, the market was correct in anticipating that a weakening economy has forced a negative shift in corporate profitability and is pressuring the labor market in ways that confirm that restrictive financial conditions are having the Fed’s desired impact of demand destruction.
To say that this week has been highly anticipated we believe would be an understatement, and waves of highly anticipated events are rarely met with benign market reactions in our opinion. As always, we are being diligent and disciplined about our positioning into this news flow as well as our anticipated reaction to potential turning points.
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