The Week Behind

Although CPI and PPI figures indicated that inflation is on a downward trajectory, the earnings of big money center banks showed a healthy outlook, causing financial markets to lower their expectations regarding real-world tightening stemming from the regional bank scare. This suggests that more Fed-tightening will be necessary to control inflation, which led to a sell-off on Friday. Despite this, all major indices ended the week with gains. The Dow outperformed with a 1.2% increase, while the S&P 500 and NASDAQ gained approximately 0.80% and 0.30%, respectively.

Highlights 

• Core CPI matched expectations at 5.6%, while headline CPI dropped by a full 1% from 6% to 5%, coming in slightly below the estimated 5.1%.
• Core PPI experienced its first negative reading since April 2020, dropping 0.1% and further supporting the decline in CPI.
• Initial Jobless Claims came in at 239k, which was around 4k higher than predicted, marking another week above the psychological 200k level.

Big Banks Inform the Regional Bank Narrative

As we head into earnings season, the general consensus regarding the regional bank scare was that big money center banks would benefit from the deposit flight to safety and that lending standards, particularly at the regional and community level, would tighten.

After reviewing earnings reports from Wells Fargo (WFC) and J.P. Morgan (JPM), it appears that this consensus has been confirmed, with the big banks being the primary beneficiaries. In fact, JPM’s strong result may have set the bar too high for competitors. Nevertheless, their overall strength is a positive sign for banks of a similar size and scope.

In the coming week, we will hear from the first batch of regional banks, which will provide valuable information on stricter lending standards. However, it’s important to note that last Friday, the market, in my opinion, mistakenly associated the health of big banks with looser lending standards. As we receive fresh information from ground zero (the regional banks), I will be closely monitoring how markets react, including changes in currency, yields, and credit.   

The Week Ahead

As we move into the first full week of earnings season, there are still a few key economic reports worth keeping an eye on. On Tuesday, housing starts and building permits data will be released, which could influence the Fed’s view on housing inflation going forward. On Wednesday, the Beige Book will be published, and market participants will be looking for insights on the labor market. Additionally, on Thursday, the leading economic indicators report will provide an update on how the economy is responding to interest rate hikes and quantitative tightening.

Turning our attention to the main event, this week brings us a range of earnings reports from various sectors. We’ll see the first earnings from regionals since the March scare, the remaining big banks, the first of the abandoned FAANGs, and bellwethers in the semiconductor and healthcare industries.

Regarding the financial sector, while a few regionals report this week, Zion (ZION), which reports on Wednesday, is among the most noteworthy. Charles Schwab (SCHW), which has been unfairly caught in the regional bank crossfire, reports on Monday, and a solid report could shift the narrative on the company as well as investors’ perceptions of regional bank contagion. Goldman (GS) and Morgan Stanley (MS) report on Tuesday and Wednesday, respectively, and given JPM’s better-than-feared investment banking figure, there is reason to be optimistic.

Beyond the financial sector, Netflix (NFLX), the first of the abandoned FAANGs, reports on Tuesday, alongside healthcare bellwether Johnson and Johnson (JNJ). Both companies have something to prove to investors: NFLX needs to demonstrate progress on their ad-tier and password-sharing solution; JNJ needs to show that litigation surrounding talcum powder is truly in the rearview.

To cap off the earnings preview, Taiwan Semiconductor (TSM), one of the world’s most integral producers, will report on Thursday morning. As semiconductor stocks often lead the market, it will be constructive for the broader market if TSM can add to the bullish momentum. Conversely, weakness here could be the first sign of a broader market correction.

The Argument for Further Earnings Revisions

As earnings season approached, I heard many analysts, even among bulls, consider further downward revisions to their full year S&P 500 earnings. 

For reference, the consensus forecast for calendar year 2023 (CY’23) is $220 per share, which is the same as calendar year 2022 (CY’22) EPS of $220. Admittedly, there is reason to believe CY’23 earnings should be less than CY’22. We know the full effects of the previous year’s aggressive Fed tightening cycle were not felt in 2022 and are more likely to impact 2023 than 2024. Moreover, March’s bank scare, which has been handled adeptly thus far, represents another headwind for growth that is not currently accounted for in current CY’23 forecasts. However, despite these known obstacles, we have yet to see any real signs of recession-like earnings degradation, which may be the reason the market is trading at valuations that seem to contradict the macro backdrop.   

At the beginning of every earnings season since the Fed began tightening, bears sound a lot like Cleveland Browns’ fans at the beginning of every football season. Without fail, bears try to convince the market that this is “their quarter”. The quarter of the collapse. Over the next three months, companies report, and the bears are proven wrong. Just for the bears to say,  “well, there’s always next quarter”.

The S&P 500’s current valuations, trading at 18x TTM and 19-20x FWD (depending on your earnings forecast), suggest that investors simply are not buying it anymore. Investors will need concrete evidence to be willing to believe in, what to this point have been, false bear promises. While the argument for lower earnings on a calendar year basis is strong, the fact that earnings have been so resilient for so long has relegated the bear thesis to a “show me story”. I am not saying that at some point this year there will not be legitimate signs of recession-like earnings compression, but it cannot be ignored that the S&P 500 is indicating investors need to see substantial evidence before they start believing a recession is right around the corner.