Earnings Outlook: Equities in Wait-and-See Mode

Summary

• The selloff last week was less about UK turmoil but rather the growing weight of inflation and recession risks.
• With the S&P 500 now 4% below our fair value measure, we expect it to trade in a range for now pending the start of 3Q earnings season.
• The consumer discretionary sector took several hits last week, with poor outlooks coming from Nike, Carnival Corp, and CarMax.
• The big earnings report this week will be Biogen as it hopefully provides more color on its new Alzheimer drug. And five consumer staples companies should provide new clues on how consumers are dealing with inflation.

What We Learned Last Week

Investors might have hoped the selloff and subsequent rally early last week was due to the brewing pension crisis in Britain and relief over the Bank of England’s intervention. And maybe they hoped equities had found a floor. But the gravity of inflation and rising prospects of recession soon reasserted themselves, and the S&P 500 (SPX) ended the week down 2.9% on the week and down 3.6% from Wednesday’s high.

The SPX is now about 4% below fair value relative to our measure of forecast earnings. It is unusual for the SPX to trade much below fair value. Absent some major new development, we expect the SPX to trade in a range until we get more visibility on the earnings outlook. We expect earnings forecasts will trend down, and the SPX with it. In the short run, the 3Q earnings season could provide a mild tailwind and bear market rally.

The NASDAQ 100 also dropped 3% last week but remains some 11% above fair value. We expect more pain here.

Micron Technology (MU), maker of memory chips, said its customers are still dealing with excess inventory of its products. It forecast depressed sales for at least the next two quarters. That bodes poorly for consumer electronics companies in the coming earning season.

On the other hand, Paychex Inc (PAYX), which provides HR-related software products, upped its outlook. It said there was good demand from smaller companies. It sees no signs of recession yet. Cintax (CTAS), which provides uniforms and other basic supplies to companies, also reported a strong beat and raised its outlook – but crucially assuming a stable economy. That is hardly a given! We suspect more companies will be offering stable or even better outlooks subject to that troubling caveat.

Results in the consumer discretionary sector were less encouraging. Nike (NKE) missed on EPS by .01 and beat on sales, but it also reported soaring inventories in China due to ongoing Covid lockdowns. Inventories are a problem elsewhere too. Its stock dropped 13% after the news. Carnival Corp (CCL) missed widely on earnings and sales and indicated future bookings were growing slowly. Its stock dropped 23%.

Used car vendor CarMax (KMX) delivered another ugly earnings message, , reporting EPS of 0.79 vs consensus 1.40. Talk about a miss! KMX pointed to three reasons – inflation making cars less affordable, higher rates that make it difficult to finance a purchase, and shaky consumer confidence.

On the positive side Thor Industries (THO), maker of RVs, posted strong results and said demand is booming. We suspect this is largely pent-up demand after Covid-related restrictions on travel and may be less sustainable than THO implies. And Vail Resorts (MTN) said bookings for winter ski trips were strong. Of course, whether that pans out will depend on both the economy and the weather.

The Week Ahead

In the final week before the 3Q earnings onslaught starts, only nine companies report, with five in the consumer staples sector.

Tuesday

• Biogen Inc (BIIB) will likely be the key report of the week after its stock soared 37% last week on news about possible Alzheimer drug.

Wednesday

• Will Keurig Dr. Pepper (KDP) follow PepsiCo (PEP) and Coca-Cola (KO) and report booming demand for soft drinks despite inflation? Or will it be a harbinger of changing preferences?

Thursday

• Commodity dealer and food producer Conagra Brands Inc (CAG) may shed light on both how agricultural commodities are adapting to changing geopolitical realities and what consumers are eating these days.
• Constellation Brands (STZ) benefited as demand for booze jumped during the pandemic as people did their drinking at home. With the revival of eating out, are people drinking less at home?
• Is spice-maker McCormick & Co (MKC) overcoming the major difficulties of last quarter with supply-chain and mismatched inventory problems?

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)