Market Snapshot
briefing.com
| Dow | 33483.51 | +81.22 | (0.24%) | | Nasdaq | 11983.22 | -143.11 | (-1.18%) | | SP 500 | 4088.13 | -13.74 | (-0.33%) | | 10-yr Note | +4/32 | 3.29 |
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| | NYSE | Adv 1073 | Dec 1818 | Vol 914 mln | | Nasdaq | Adv 1500 | Dec 2983 | Vol 4.3 bln |
Industry Watch
| Strong: Utilities, Health Care, Consumer Staples, Energy |
| | Weak: Consumer Discretionary, Information Technology, Industrials, Materials, Real Estate |
Moving the Market
-- Consolidation trade after a big run recently
-- Weaker than expected ADP Employment Change Report and widening trade deficit feeding into slowdown concerns
-- Treasury yields moving lower
-- Weakness from mega cap stocks
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Closing Summary
05-Apr-23 16:30 ET
Dow +80.34 at 33482.63, Nasdaq -129.47 at 11996.86, S&P -10.22 at 4091.65
[BRIEFING.COM] The stock market had a weak showing today. Money flowed into blue chip names and countercyclical sectors while more economically-sensitive sectors logged decent losses following another batch of weak economic data this morning.
Briefly, the ADP Employment Change for March was weaker than expected (actual 145,000; Briefing.com consensus 205,000), the February trade deficit widened more than expected (actual $70.5 billion; Briefing.com consensus -$69.0 billion) with monthly declines in exports and imports, and the March ISM Non-Manufacturing Index was weaker than expected (actual 51.2%; Briefing.com consensus 54.5%).
Buying interest picked up in the Treasury market following the data releases. Equities didn't respond positively to the drop in market rates, though, due to a sense that a weaker economic backdrop will translate into further cuts to earnings estimates. The 2-yr Treasury note yield fell eight basis points to 3.76% and the 10-yr note yield fell five basis points to 3.29%. The U.S. Dollar Index rose 0.3% to 101.91.
The main indices spent most of the morning in a slow grind lower, but climbed off their worst levels of the day by the closing bell. Index level losses were paced by the Nasdaq (-1.1%) while the Dow Jones Industrial Average (+0.2%) squeezed out a slim gain, benefitting from blue chip favoritism. Johnson & Johnson (JNJ 165.61, +7.12, +4.5%) and UnitedHealth (UNH 509.23, +15.98, +3.2%) were among the biggest winners in the Dow.
Shares of Johnson & Johnson moved on news that its subsidiary LTL Management re-filed for voluntary Chapter 11 bankruptcy protection to resolve claims from cosmetic talc litigation and will pay an $8.9 billion settlement. UnitedHealth reacted to an upgrade to Strong Buy from Outperform at Raymond James.
Unsurprisingly, JNJ and UNH helped boost the S&P 500 health care sector (+1.7%) toward the top of the leaderboard today. Utilities (+2.6%), energy (+1.4%), and consumer staples (+1.4%) were the only other sectors to close with a gain.
Meanwhile, the information technology (-1.2%), industrial (-1.3%), and consumer discretionary (-2.0%) sectors were the top laggard today.
- Nasdaq Composite: +14.6% YTD
- S&P 500: +6.5% YTD
- S&P Midcap 400: +0.9% YTD
- Dow Jones Industrial Average: +1.0% YTD
- Russell 2000: -0.5% YTD
Reviewing today's economic data:
- The weekly MBA Mortgage Applications Index fell 4.1% with purchase applications falling 4.0% and refinancing applications declining 5.0%.
- The ADP Employment Change Report for March showed private sector employment increasing by 145,000 (Briefing.com consensus 205,000) following an upwardly revised 261,000 (from 242,000) in February. Weak pockets included manufacturing (-30,000), financial activities (-51,000), professional/business services (-46,000), and information (-7,000).
- The February Trade Balance Report showed a widening in the trade deficit to $70.5 billion (Briefing.com consensus -$69.0 billion) from a downwardly revised $68.7 billion (from -$68.3 billion) in January. Exports were $6.9 billion less than January exports and imports were $5.0 billion less than January imports.
- The key takeaway from the report is that the decline in both exports and imports is reflective of a slowdown in global trade activity.
- The March IHS Markit Services PMI fell to 52.6 in the final reading from 53.8.
- The ISM Non-Manufacturing Index for March dropped to 51.2% (Briefing.com consensus 54.5%) from 55.1% in February. The dividing line between expansion and contraction is 50.0%, so the March reading reflects continued growth in the services sector, albeit at a demonstrably slower pace than the prior month.
- The key takeaway from the report is that activity in the U.S. economy's largest sector is slowing noticeably with a cooling off in the new orders growth rate. The slowdown in activity and improved supply chain dynamics, though, have helped temper the pace of price increases for services.
- The weekly EIA Crude Oil Inventories showed a draw of 3.74 million barrels following last week's draw of 7.49 million barrels.
Looking ahead to Thursday, market participants will receive the following economic data:
- 8:30 a.m. ET: Weekly initial (Briefing.com consensus 203,000; prior 198,000) and continuing (prior 1.689 million) jobless claims
- 10:30 a.m. ET: Weekly EIA Natural Gas Inventories (prior -47 bcf)
Market remains little changed ahead of the closing bell
05-Apr-23 15:30 ET
Dow +72.80 at 33475.09, Nasdaq -150.73 at 11975.60, S&P -14.70 at 4087.17
[BRIEFING.COM] Things are little changed in the last half hour.
The 2-yr Treasury note yield fell eight basis points today to 3.76% and the 10-yr note yield fell five basis points to 3.29%. The U.S. Dollar Index rose 0.3% to 101.91.
Looking ahead to Thursday, market participants will receive the following economic data:
- 8:30 a.m. ET: Weekly initial (Briefing.com consensus 203,000; prior 198,000) and continuing (prior 1.689 million) jobless claims
- 10:30 a.m. ET: Weekly EIA Natural Gas Inventories (prior -47 bcf)
Energy complex settles mixed
05-Apr-23 15:00 ET
Dow +81.22 at 33483.51, Nasdaq -143.11 at 11983.22, S&P -13.74 at 4088.13
[BRIEFING.COM] The Dow Jones Industrial Average and S&P 500 have been trying to move somewhat higher while the Nasdaq remains little changed in recent action.
Energy complex futures settled the session in mixed fashion. WTI crude oil futures fell 0.1% to $80.61/bbl and natural gas futures rose 1.2% to $2.14/mmbtu. On a related note, the S&P 500 energy sector (+0.9%) joined the utilities (+2.6%), health care (+1.9%), and consumer staples (+0.8%).
Market breadth remains decidedly negative despite modest index level improvement. Decliners lead advancers by a roughly 2-to-1 margin at both the NYSE and the Nasdaq.
MarketAxess, Caesars among top laggards in S&P 500 on Wednesday
05-Apr-23 14:25 ET
Dow +64.72 at 33467.01, Nasdaq -150.37 at 11975.96, S&P -15.82 at 4086.05
[BRIEFING.COM] The S&P 500 (-0.39%) is down about 15 points today, more than half (seven) of the sectors in negative territory.
S&P 500 constituents MarketAxess (MKTX 340.26, -52.03, -13.26%), Caesars Entertainment (CZR 45.84, -3.00, -6.14%), and Tapestry (TPR 40.43, -1.73, -4.10%) pepper the bottom of the standings. MKTX shows weakness following the release of March & Q1 volume metrics, while CZR and consumer discretionary peers fall after the ISM Non-Manufacturing Index for March reflected slowing growth in the services sector, with TPR mirroring weakness in retail stocks (XRT -2.3%).
Meanwhile, Illinois-based medtech firm Baxter (BAX 42.45, +1.95, +4.81%) is near the top of the S&P, benefiting in part from broader strength in the healthcare sector.
Gold modestly lower as dollar strength, yield weakness keeps losses small
05-Apr-23 14:00 ET
Dow +56.28 at 33458.57, Nasdaq -155.45 at 11970.88, S&P -16.79 at 4085.08
[BRIEFING.COM] With about two hours to go on the penultimate session of the holiday-shortened week the tech-heavy Nasdaq Composite (-1.28%) remains the worst-performing major average.
Gold futures settled $2.60 lower (-0.1%) to $2,035.60/oz, losses kept mostly at bay as dollar strength is offset by weakness in yields.
Meanwhile, the U.S. Dollar Index is up about +0.4% to $101.97.
Looking at the market bit by bit
The stock market finished the month of March on a roll, yet the start of April has seen a bit of a rollover. Emphasis should be placed on the word bit. The S&P 500 is down only 0.2% for the week, mirroring the loss in the Vanguard Mega-Cap Growth ETF (MGK). The Invesco S&P 500 Equal Weight ETF (RSP), however, is down 0.9%.
In other words, the consolidation trade has been a bit more prominent below the surface. The Nasdaq Composite is down 0.8%.
Small-cap and mid-cap indices have had a bit harsher treatment to begin April. Hurt primarily by losses in bank stocks, the Russell 2000 and S&P Midcap 400 are down 1.8% this week.
The outlier at the moment is the Dow Jones Industrial Average, which is up 0.4% for the week.
There isn't a lot of movement in the major indices expected at today's open. Currently, the S&P 500 futures are down eight points and are trading 0.2% below fair value, the Nasdaq 100 futures are down 17 points and are trading 0.1% below fair value, and the Dow Jones Industrial Average futures are down 45 points and are trading 0.2% below fair value.
Those indications should translate into a bit more weakness for the major indices. What's notable is that the equity futures market isn't getting any lift from another drop in market rates.
The 2-yr note yield is down 10 basis points to 3.74% and the 10-yr note yield is down five basis points to 3.29%. Those moves have followed another round of economic data that was weaker than expected.
The ADP Employment Change Report for March showed private sector employment increasing by 145,000 (Briefing.com consensus 205,000) following an upwardly revised 261,000 (from 242,000) in February. Weak pockets included manufacturing (-30,000), financial activities (-51,000), professional/business services (-46,000), and information (-7,000).
Separately, the February Trade Balance Report showed a widening in the trade deficit to $70.5 billion (Briefing.com consensus -$69.0 billion) from a downwardly revised $68.7 billion (from -$68.3 billion) in January. Exports were $6.9 billion less than January exports and imports were $5.0 billion less than January imports.
The key takeaway from the report is that the decline in both exports and imports is reflective of a slowdown in global trade activity.
The slowing economic activity is something the Fed will likely be pleased to see, yet it appears to be giving the stock market some cause for pause after its strong run off the mid-March lows. That run has left the S&P 500 trading at 18.2x forward twelve-month earnings, which is a premium to the 10-yr historical average of 17.3x, according to FactSet.
The cause for pause relates to concerns that the weak economic data is presaging a weaker earnings outlook that has yet to be captured in analysts' consensus estimates, meaning there is a bit of a valuation headwind impeding the stock market's progress at this juncture.
In a few weeks, when the Q1 earnings reporting period gets rolling, market participants will have a better sense if that headwind will get stronger or dissipate. For now, it is a bit of nuisance.
-- Patrick J. O'Hare, Briefing.com
Johnson & Johnson rallying on hopes that it can put talc-based litigation behind it (JNJ)
Dow component Johnson & Johnson (JNJ) is rallying higher on hopes that the pharmaceutical giant is moving closer to putting its long-standing talc litigation behind it. Last night, JNJ announced that the subsidiary it created to handle cancer victims' claims, LTL Management, re-filed for bankruptcy protection and has agreed to contribute up to $8.9 bln to resolve all current and future claims. That amount is much higher than the $2.0 bln figure that JNJ previously committed to, which many viewed as insufficient.
There is no guarantee that this latest attempt by JNJ to use bankruptcy as a means to end its litigation troubles will succeed.
- Recall that last year, a court threw out JNJ's original bankruptcy case and sided with the cancer victims, many of whom believed that JNJ was trying to prevent their stories from being told in court.
- After a bankruptcy judge allowed JNJ to proceed with its plan, a federal appeals court overturned that decision in January, paving the way for victims to continue filing personal litigation against JNJ.
- The company took its case to the U.S. Court of Appeals, but it received more bad news last month when the court denied its request for a rehearing of the LTL bankruptcy petition.
However, there is reason to be optimistic that this latest bankruptcy attempt will go through.
- According to the company, LTL has secured commitments from over 60,000 current claimants to support a resolution on the new terms. If 75% of plaintiffs are on board with JNJ's plan, then the company will be free to pay claims through the LTL trust.
- Importantly, that doesn't necessarily mean that all of the other terms of the resolution -- including the $8.9 bln pay out -- are also finalized. It's quite possible that JNJ's contribution amount could increase as negotiations move forward.
- JNJ also continues to contend that there's no consensus among medical experts or scientists regarding talc-based powders and its link to ovarian cancer and mesothelioma. Of course, many vehemently disagree with that position, and it's also worth noting that JNJ stopped selling talc-based powders in 2020 as concerns about its health risks grew.
- Consequently, JNJ's Consumer Health segment has struggled to recover from the negative publicity and lost sales from its baby powder products.
- In the near future, though, JNJ will cut itself loose from its Consumer Health business as it continues its transition to a pharmaceutical and medical device company. By focusing on pharmaceuticals and medical devices, JNJ believes the change will allow it to become simpler, faster and more focused. In Pharmaceutical, JNJ's goal is to hit $60 bln in revenue by 2025 despite the Stelara loss of exclusivity in September 2023.
The bottom line is that by using bankruptcy and coming to a settlement agreement with a majority of the plaintiffs, JNJ could avoid a litigation process that could take more than a decade to fully play out. Therefore, a major overhang may be removed from the stock if JNJ's second crack at using bankruptcy works out.
FedEx edges higher on a string of major announcements during its DRIVE Investor event today (FDX)
FedEx (FDX +1%) investors are signing off on the company's major announcements during its DRIVE Investor event today, sending shares toward August highs. The delivery giant discussed various topics related to its ongoing DRIVE program, which launched late last year and is focused on creating a more efficient and profitable business. FDX also increased its annual dividend by 10% to $5.04 per share, giving it a solid 2.2% yield.
- The headline announcement was FDX reiterating its goal of achieving $4.0 bln in permanent cost reductions, which it noted it was on track to reach by the end of FY25 (May) during its Q3 (Feb) call last month.
- Perhaps the much more significant announcement was FDX transitioning each of its businesses into one organization called "One FedEx." This process will take time, with FDX splitting it into two stages. The first phase will be realigning the company's executive officer structure, with FedEx Ground CEO John Smith assuming leadership of all U.S. and Canada surface operations and FedEx Express CEO Richard Smith continuing his leadership of FedEx airline and international operations. The second stage will consolidate FDX's business lines into One FedEx, planned for June 1, 2024.
- The combination of FDX's DRIVE initiative and One FedEx will result in an additional $2.0 bln in savings in FY27. Management is also optimistic that this transformation will boost operating margins to 10%, a considerable expansion from the 4.7% delivered in Q3, which represented a 90 bp decline yr/yr.
Although FDX is undergoing a massive overhaul to better unify the company, investors are not expressing the same level of excitement as management did during its presentation. We believe this is due to the broader lingering concerns surrounding the global economy. FDX estimates e-commerce will drive 90% of parcel market growth, with volumes climbing by 4-5% between 2022 and 2026. This is a somewhat conservative outlook as it incorporates the current economic slowdown and normalization of e-commerce growth. FDX's estimates may also need to be revised downward unless economic conditions stabilize or improve. Furthermore, the labor market remains tight, which could pressure margin expansion as FDX is forced to raise wages to attract and retain workers.
Still, FDX's DRIVE program and plans to unify operations are commendable. As United Parcel Service (UPS) and Amazon (AMZN) look to capture a piece of the e-commerce-driven package delivery pie, FDX's moves to streamline its corporate structure to boost its bottom line will be a vital component of maintaining and growing its current position.
Walmart reassures investors with reaffirmed outlook as consumer spending remains steady (WMT)
With its 2023 investor and analyst conference underway, Walmart (WMT) reaffirmed its EPS and net sales growth guidance (in constant currency) for 1Q24 and FY24, while also reiterating its goal of achieving 4% sales growth and 4%+ operating income growth over the next 3-5 years. The retail giant's affirmed outlook offers some relief that consumer spending hasn't softened further since the company reported Q4 results on February 21.
- On the other hand, WMT's guidance was initially viewed as disappointing as its EPS forecast of $1.25-$1.30 for 1Q24 and $5.90-$6.05 for FY24 each fell short of expectations. Furthermore, WMT chose not to provide Q1 comp guidance in its Q4 earnings report and again refrained from issuing Q1 comp guidance last night. The company did, however, reaffirm its FY24 comp growth guidance of 2.0-2.5%.
- When WMT provided its outlook in February, there was some hope that the company was just taking an overly conservative approach with its expectations. During the earnings call, CEO Doug McMillon took a cautious tone regarding the macro environment, particularly due to the impact of high inflation on the consumer. Those pressures apparently haven't receded enough for WMT to nudge its conservative guidance higher.
Still, the reaffirm of its guidance, combined with some enthusiasm about WMT's longer-term growth and margin expansion potential, is enough to push shares higher today.
- The key components that WMT expects to support its financial framework over the next 3-5 years include expanding its omni-channel business model, diversifying its business through improved category mix, and scaling high-return investments that drive operating leverage.
- Over the past few years, and especially during the pandemic, WMT significantly ramped up its omni-channel strategy. Now, the company is looking to build upon those efforts through advertising, data, and memberships.
- WMT also unveiled a new plan to create a more connected and automated supply chain that will rely on data and software to improve productivity and efficiency at its distribution centers and facilities.
- By FY26, the company believes that about 65% of its stores will be serviced by automation, and approximately 55% of its fulfillment center volume will move through automated facilities.
- How this plan will impact the thousands of workers at WMT's facilities remains to be seen, but the company argues that the transition may actually lead to a higher number of workers as new positions are created.
Overall, WMT's update is a positive data point not only for the company, but for the broader retail sector as well -- especially for those with a significant amount of non-discretionary sales. On that note, Costco (COST), which is also benefitting from value-conscious consumers looking to lower their grocery bills, is trading a bit higher with WMT reaffirming its FY24 U.S. comp sales growth of about 5.0% for Sam's Club.
Conagra's elasticities remained consistent in FebQ, fueling another double-digit EPS beat (CAG)
Conagra (CAG +2%) is pushing higher today after delivering another round of top and bottom line upside in Q3 (Feb). The consumer packaged goods giant, which owns numerous brands like Slim Jim and Vlasic, also increased its FY23 (May) adjusted earnings guidance to $2.70-2.75 from $2.60-2.70.
- CAG grew its adjusted earnings by over 31% yr/yr to $0.76, topping estimates by double-digits, its second consecutive quarter boasting double-digit upside, a positive shift from CAG's typical low-single-digit beats. Meanwhile, revenue continued steadily expanding, jumping by 5.9% yr/yr to $3.09 bln, CAG's sixth-straight quarter of growth.
- Refrigerated & Frozen, CAG's largest segment, climbed 5.6% yr/yr to $1.3 bln. The business boasted additional market share gains in select categories, like frozen sides and breakfast sausage, a recurring theme over the past few quarters.
- Grocery & Snacks, CAG's second-largest segment, followed closely behind at 3.7% growth to $1.2 bln, with further share gains in many different snacking categories.
- Foodservice saw the most significant growth at 17.3% to $275 mln, with volumes shrinking by just 1.2%, highlighting an ongoing rebound in the food service industry as this segment has boasted double-digit gains for eight consecutive quarters.
- International sales growth of 7.7% to $260 mln reflected stable demand overseas.
- Inflation-driven pricing actions were vital to CAG's revenue growth, evidenced by price/mix improving by 15.1% yr/yr. Additionally, it is worth noting that elasticities remained consistent with past quarters in Q3, a testament to CAG's brand power. Meanwhile, CAG's service levels, which advanced to around 90% last quarter, continued to show modest improvements in Q3, exceeding this level in the quarter.
- These positive developments culminated in adjusted gross margins expanding by over 400 bps yr/yr to 28.1%. The considerable jump in margins not only fueled CAG's surprise profit but also allowed management to slightly up the low end of its FY23 margin outlook. The company now expects adjusted operating margins of 15.5-15.6% in FY23, narrowed from 15.3-15.6%.
There were still a few blemishes worth pointing out. CAG trimmed the high end of its organic net sales outlook for FY23, forecasting +7.0-7.5% growth yr/yr compared to its previous guidance of +7.0-8.0%. Also, volumes continued to fall, contracting by 9.0% yr/yr in Q3, CAG's eighth-straight quarter of declining volumes. Although the market was likely not pricing in volume growth in Q3, given CAG's several price hikes over the past few quarters, the accelerating decline from the previous three quarters is still a concern.
Nevertheless, CAG's business model, which may not lean on AI trends or exciting technology, continues to demonstrate its ability to thrive despite a volatile environment. Even though shares have run up around 9% from March lows, they are still staring at plenty of upside as CAG's financials should improve as supply chains become less disruptive and CAG's input costs ease up more meaningfully.
On a final note, CAG and peer General Mills (GIS) posted solid results during FebQ, a bullish sign ahead of many of its competitors' earnings reports over the next month, including Mondelez Int'l (MDLZ), Kellogg (K), and Post (POST).
Cardlytics soaring after lifting guidance, providing hope that a turnaround is in motion (CDLX)
Cardlytics (CDLX), the operator of an advertising platform that utilizes data from the banking rewards programs it runs for its financial partners, is soaring today on a massive surge in volume after the company raised its Q1 guidance. The company now expects to generate revenue of $63.5-$66.5 mln, up from its original forecast of $54-$63 mln, and adjusted EBITDA of ($8.0)-($5.0) mln compared to its prior outlook of ($17.0)-($10.0) mln. Recently appointed CEO Karim Temsamani credited better than expected growth in the U.S. business, in addition to the impact from product optimizations, for the improved outlook.
The beleaguered company was badly in need of some good news.
- Since the beginning of 2022, the stock had cratered by about 95% prior to today's surge. Of course, as the operator of an advertising platform, the company has been deeply affected by the steep pull-back in marketing spending. This is reflected in CDLX's poor financial results which include twelve consecutive quarters of net losses. Additionally, revenue growth slipped into negative territory for the first time since 4Q20 last quarter.
The company's struggles instigated an overhaul of its executive team, as well.
- Last September, CDLX appointed Mr. Temsamani as its new CEO, succeeding Lynne Laube, who announced her intention to retire. Temsamani joined CDLX after serving as Head of Global Partnerships for leading fintech company Stripe.
- A few months later, the company named Amit Gupta as its new COO, who also came over from Stripe where he was Head of Strategy and Operations for Global Partnerships.
- This appointment was followed by the resigning of CDLX's CFO, Andy Christiansen, who will leave his post on July 21, 2023. The company is currently searching for his replacement.
While it's far too soon to declare victory, it appears that the changes at the top have CDLX moving in the right direction.
- On the cost side, CDLX successfully implemented $35 mln in expense reductions by the end of December, which are now taking effect in Q1. More cuts are anticipated, too, with Temsamani stating that he's focused on achieving positive cash flow in 3Q23.
- Simultaneously, the company is improving and upgrading its ad platform to support modern ad ranking models in order to drive higher monetization rates and provide more relevancy for its customers. Specifically, CDLX believes it can drive an improvement in RPMs of10-15% in 2H23.
- Furthermore, the company is exploring new pricing models that are more tied to impression events, while putting in place processes that allow it to track product performance more effectively.
The bottom line is that CDLX's improved outlook clearly caught investors by surprise, providing some much-needed hope that its new management team can finally turn things around.
The Big Picture
Last Updated: 05-Apr-23 14:46 ET | Archive
A high valuation hurdle going into Q1 earnings reporting period
It seems only fitting that the first quarter earnings reporting period will start with a cascade of results from the banking industry -- the same banking industry that will purportedly be a big contributor to a sharp slowdown in economic activity, if not a recession, as this year unfolds.
That has been the thinking anyway since the failure of Silicon Valley Bank and Signature Bank in March, which lit the regional bank stocks on fire and triggered a wave of concerns about possible bank runs.
The Federal Reserve has worked to pre-empt such runs. Regardless, the whole episode, which JPMorgan Chase CEO Jamie Dimon said is not over yet and will have repercussions for years to come, has fueled a belief that banks will tighten their lending standards, manage their balance sheets more conservatively, and experience net interest margin pressure as they are forced to raise interest rates on deposit accounts in an effort to keep those deposits from fleeing.
We said in our prior column that it is not a good thing for growth prospects when banks go into protection mode, because credit is the lifeblood of economic expansion. When there are blood clots in the flow of credit, the economy suffers.
In this instance, though, it will be suffering on top of delayed suffering. We say "delayed" because the economy has held up reasonably well despite the Fed's aggressive rate hikes, yet the lag effect of those rate hikes -- and rate hikes by other central banks around the world -- should start bubbling to the surface in a more noticeable fashion as the year progresses.
That should ultimately translate into worsening earnings prospects.
Margin Pressures on Display
The prospects as they relate specifically to the first quarter are not good. According to FactSet, the estimated earnings decline for the S&P 500 was -6.6% as of March 31. The bottom-up EPS estimate of $50.75 decreased by 6.3% between December 31 and March 30 compared to an average decline of 2.8% for the past 20 quarters.
Revenue for the first quarter is expected to increase 1.9%, yet that outlook has also been revised lower. On December 31, the revenue growth outlook stood at 3.4%.
The fact that first quarter earnings are projected to decline when first quarter revenues are expected to increase speaks to the margin pressures companies are facing from higher costs, primarily for labor, as well as a slowdown in demand from prior quarters. Revenue growth of 1.9% would be the lowest growth since the third quarter of 2020, according to FactSet.
Ten of the 11 S&P 500 sectors have seen downward revisions to earnings estimates since the end of the fourth quarter. The materials, energy, health care, consumer discretionary, and industrials sectors have paced the revisions. The only sector that has escaped the downward revisions since December 31 has been the utilities sector.
An Egregious Premium Valuation
So, the aggregate earnings estimate for the S&P 500 has decreased 6.3% since December 31, but as of March 31 the S&P 500 was up 7.0% for the year. Go figure.
The basis for the market's strong showing was the outperformance of the mega-cap stocks. To be fair, the Invesco S&P 500 Equal Weight ETF (RSP) was up 2.3% for the year as of March 31, so the multiple expansion (which is what happens when the price of the index goes up as earnings estimates come down) wasn't just a "mega-cap thing."
The latter point notwithstanding, it was rather egregious, given a backdrop that has included higher interest rates, stubbornly high inflation, an ongoing war in Ukraine, and a regional banking crisis, to see the market trading at a premium multiple of 18.2x forward twelve-month earnings on March 31 versus a 10-year historical average of 17.3x.
The historical average, by the way, is computed over a 10-year period when the 10-yr note yield averaged 2.17% and core-PCE inflation averaged 2.12%. Today, the 10-yr note yield sits at 3.29% and core-PCE inflation is up 4.6% year-over-year.
Granted rates have come in sharply following the banking crisis, but if one accepts that they have come in because that banking crisis will invite bad economic times that compel the Fed to start cutting interest rates, then one can't ignore that those bad economic times will also translate into weaker earnings prospects.
Just how much weaker is the $64,000 question.
The current forward twelve-month earnings estimate is $226.54, according to FactSet. At today's price, that leaves the S&P 500 trading at 18.0x forward twelve-month earnings.
However, if estimates are cut by 10%, the market at today's prices is trading at 20.0x forward twelve-month earnings. When the Fed made its first rate hike on March 16, 2022, the S&P 500 was trading at 19.0x forward twelve-month earnings.
What It All Means
Clearly, there is a lot riding on the earnings guidance coming out of the first quarter earnings reporting period.
The S&P 500 sits near the upper end of a nine-month trading range, sporting a premium valuation that rests on a favorable outcome for the economy that the Treasury market suggests is unlikely.
Should the earnings guidance defy the Treasury market's expectations, the stock market could have something to build on -- until, of course, rising interest rates get in its way again.
What is standing in its way now is the semblance of a decelerating run by the economy into a high valuation hurdle. Disappointing earnings guidance would trip up the stock market's rebound effort.
-- Patrick J. O'Hare, Briefing.com
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