By J. Keith Buchanan, CFA, Portfolio Manager
A few times this year, we have revisited the topic of corporate earnings as a pulse check on risk markets, particularly equity markets. Macroeconomic crosswinds these days are persistently unprecedented. One could make that same statement about the economy since early 2020. We have experienced historic development after historic development. But now the market is faced with one central question. Can our economic momentum coming out of the pandemic-induced recession of spring 2020 withstand inflationary pressures and tightening monetary policy? So far, the results have been mixed. Real GDP has declined over the last two quarters, an indication of softening demand. While the labor market has been resilient with unemployment at historically low levels. There is no surefire “north star” for investing in times like this, but, in my opinion, watching what companies are saying about their businesses going forward is very telling and can give a picture of what can be expected for broader macroeconomic trends.
We saw this case-in-point with FedEx’s recent preannouncement. The market sold off the next day as investors digested FedEx’s CEO comments about slowing demand and an impending recession. A few days later, Ford issued its own profit warning. This was all after General Electric warned that supply chain issues were having a negative impact on profits. The market collectively began to question if our expectations for corporate profits are fair given the current environment.
But what does the market expect? The market expects 3.2% earnings growth in the 3rd quarter of 2022 which will soon be reported. However, the S&P 500 is trading at 15.8 times forward earnings which is below the 10-year average of 17. We interpret this development to indicate that the market has doubts about expected earnings which raises the importance of the upcoming corporate earnings reporting season.
Will companies confirm the fears of the marketplace? If the reaction to FedEx’s preannouncement is any indication, stocks still have the propensity to inject fresh selling pressure if companies confirm pessimism surrounding the demand environment and competitive dynamics.
Will companies stave off doubts about their revenue growth opportunities and profitability? For full year 2022, analysts are projecting revenue growth of 10.7% and earnings growing slower at 7.7%. This implies a level of margin degradation that carries with it the potential to be refuted by company results and commentary. Inflationary expectations are real and have caused a reckoning of sorts across all asset classes. However, the degree to which corporations can manage and pass along those cost pressures is yet to be determined.
Each earnings reporting season enlightens onlookers to certain aspects of our current economic condition. This 3rd quarter of 2022 earnings season will be no different. Market participants will look to make progress toward confirmation of hopes or fears of inflation and tightening monetary policy’s impact on corporate America’s bottom line.
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