Economic and Geopolitical Events are Shaking up Q3 Corporate Earnings

October 19, 2023  |  Tim Fortier

Earnings season is again upon us as companies report for the 3rd quarter.

The outlook for earnings is weakening and could remain subdued, according to strategists from Morgan Stanley to JPMorgan Chase & Co.

As the reporting season kicks off, Morgan Stanley’s Michael Wilson said earnings revisions breadth — referring to the number of stocks seeing upgrades versus downgrades — for the S&P 500 has fallen sharply over the past couple of weeks.

Given this is a time of year when earnings revisions tend to see an upward inflection in breadth, further underperformance “would be a sign that other cyclical risks, including macro headwinds, are driving the earnings revisions backdrop,” Wilson wrote in a note.

Citigroup Inc.’s index of earnings revisions shows downgrades have outpaced upgrades for four straight weeks ahead of the reporting season. JPMorgan strategist Mislav Matejka expects this to continue.

The prospect of higher-for-longer interest rates has unnerved markets this month, with the 10-year Treasury yield hitting the highest in over a decade.

Investors are bracing for the Federal Reserve to keep policy tight, rekindling recession concerns that have been heightened by conflict in the Middle East.

Corporate earnings are currently at a crucial point within the upper boundary of a 70-year channel and are poised to begin declining, even in the face of unwarranted optimism surrounding the idea of a soft landing.

The combination of deglobalization trends, wage pressure, and the rising cost of debt are likely to exert pressure on companies’ profit margins, and corporate fundamentals are yet to reflect these issues.

Despite this, the U.S. economy has demonstrated undeniable resilience in the last nine months.

And so far, reports of the death of the U.S. consumer have been greatly exaggerated.

On Tuesday, it was reported that consumers showed surprising strength in September, boosting retail sales well above expectations despite high interest rates and worries over a weakening economy.

Retail sales rose 0.7% on the month, well above the 0.3% Dow Jones estimate, according to the advance report the Commerce Department released Tuesday.

Just a few short weeks ago, the consensus view on Wall Street was that the U.S. consumer was set for a major slowdown.

Layoff announcements had been on the rise since the beginning of the year, wage growth was slowing, and student loan payments were set to resume in October.

On top of it all, everyone agreed that excess savings from the pandemic – when direct checks from the government caused personal incomes to spike at an unprecedented rate – were drying up.

However, there can be a lagged effect as monetary policy is increasingly felt.

As an example, the home building market is now reflecting the impact of higher mortgage rates as builder sentiment has dropped for four consecutive months.

Over 60% of home builders are now offering incentives as builders have reported lower levels of buyer traffic, particularly among younger ones who are being priced out of the market.

And it’s not going to get any easier.

Mortgage rates hit 8% on Wednesday, the highest level since August 2000 and deepening an affordability crisis for homebuyers.

Higher borrowing costs — paired with elevated prices — have made home buying unaffordable for a larger swath of buyers, economists and researchers say.

In about a dozen U.S. states, families with a median income for their area cannot afford a mortgage, according to recent research from Moody’s. That’s up from only two states in 2019.

Homebuilder stocks have started to pullback but have actually performed better than the broader market over the past year, with XHB (SPDR Homebuilders) + 24% vs. SPY (SPDR S&P 500) + 15.77%.

For stocks in general, one factor that could begin to squeeze operating margins is interest costs.

9% of corporate bonds are set to mature in the next two years.

This is the highest level since the Financial Crisis.

High-interest rates will make refinancing more difficult and will favor companies with low debt-to-equity ratios.

Without question, interest rates will continue to play a key role. The yield on the U.S. 10-year note is once again surging higher and seems likely to reach yields north of 5%.

For investors, the combination of rising rates, geopolitical tensions, and economic headwinds provides an unsettling backdrop to corporate earnings.

And among earnings, none are more important than the following stocks which make up 31.31% of the S&P 500.

It has been the performance of these stocks that has led to the positive market performance in 2023.

Representing nearly one-third of the S&P 500 weight, these company’s earnings reports can have a major impact on the overall market.

Technically, the FAANG index looks to be under distribution.

Selling volume has increased and the index has started to make lower lows and lower highs – the definition of a downtrend.

So far, Investors have seen Tesla miss both earnings and revenue estimates for the first time since 2019.

The quarter’s net earnings amounted to $1.85 billion, equating to 53 cents per share.

There was a 22% decrease in total gross profit compared to the previous year.

The total operating margin was 7.6%, marking a substantial drop from the 17.2% observed in the same quarter the year before.

Tesla warned that the Cybertruck would not bring positive cash flow in the first 12-18 months.

Elon Musk was very pessimistic when it came to the state of the macro-economy and shares have lost nearly 10% on the news in Thursday’s trading.

Among the FAANG stocks, with a greater than 7% weighting to the S&P 500, all eyes will be on Apple (AAPL) when the company reports on November 2.

Microsoft (MSFT) is expected to report on October 24 which will be followed by Amazon (AMZN) on October 26.

Chip maker Nvida is not scheduled to report until November 15th.

Until then…

If you’d like to talk more about how Avalon can help you position yourself to be ready for the changing markets, you can schedule an appointment today with one of our experienced advisors who will guide you through our various adaptive investment models.





Get Our FREE Guide

How to Find the Best Advisor for You

Learn how to choose an advisor that has your best interests in mind. You'll also be subscribed to ADAPT, Avalon’s free newsletter with updates on our strongest performing investment models and market insights from a responsible money management perspective.

Avalon_NewGradient_24Feb22 copy