Earnings, Markets & The Economy

Daniel Hawley |

A recent research report released by Absolute Strategy Research revealed that 37% of money managers (who collectively oversee $5.2 trillion in assets) expect earnings to be higher a year from now. 63% expect earnings to be lower. That’s the lowest reading since late 2015.

The economic outlook is fraught with issues that we have discussed at length in prior articles.

a) Consumer sentiment has hit a 10 year low. This is correlated with more cautious consumer behavior and a decline in spending which will impact earnings.

b) As interest rates continue to be hiked, the cost of credit rises which will impact earnings and capital expenditures.

c) Wage push and commodity price inflation is embedded in the economy. The number of job openings still exceeds the number of applicants. Passing these costs onto the consumer will become less feasible as consumer spending declines. Consumer goods companies are shifting tactics to sizing down portions as a way to pass on rising costs to the consumer.

d) A stronger dollar will impact companies whose exports are a meaningful part of their revenue.

While all the above factors are true, the US economy is still close to full employment levels which suggests that any recession may be a short-lived one. A decline in earnings forecasts for many companies is the most likely outcome given the above factors. At this time, revisions in earnings may not be fully baked into current market valuations. Thousands of companies across every industry sector will be reporting earnings over the next two months and it remains to be seen how many of these announce revised earnings forecasts.

Industries that have suffered steep losses such as crypto currency have aggressively cut employees. Coin base, one of the largest crypto currency exchanges in the world cut 18% of its workforce. Industries impacted by the current economic climate such as consumer facing businesses may see employee cuts during this time as businesses look to weather the current economic climate and downturn in consumer spending.

The markets are a discounting mechanism. As they are forward looking they are prone to error and are constantly adjusting or discounting future earnings based on the evidence they see. Market participants differ in their outlook and how they interpret economic evidence plus have different investment horizons and liquidity which makes a market of buyers and sellers.

The report released by Absolute Strategy Research shows that the majority of fund managers are bearish. How much more does the market need to discount earnings? That question will be answered over the coming two months and beyond. If earnings do need to be discounted further, continued weaknesses in consumer sentiment and further delays in bringing down inflation will continue to impact the outlook on earnings.

It is important to remember that this is a shorter term narrative. When viewed in the context of the long term market outlook it is less important. Over the long term markets have weathered world wars, depressions and recessions. They have continued to rise in value over the long term. In this context, the short term narrative is less important. Recessions can - in the context of the long term - be opportunities for those who have strong cash positions to acquire world class companies whose earnings are steady but whose stock prices have fallen substantially.

It is very hard not to be impacted by headlines that are screaming "recession", "high inflation" and "war" as the markets fall. Having a financial advisor can help you sleep better at night as they can provide a more objective perspective about the markets and your unique situation and objectives.