The Fed raises rates 75 basis-points … what’s the latest on earnings? … corporate layoffs are beginning to grow … will tomorrow reveal that we’re in a recession?
Today, the Fed matched expectations by raising rates 75 basis-points.
The central bank has now raised rates in four consecutive meetings, bringing the target fed funds rate to a range of 2.25%–2.50%. This is comparable to levels in 2019.
Wall Street was already in a good mood before the Fed’s announcement, with all three indexes up comfortably.
Once the rate hike hit the news, stocks edged even higher after it was clear there would be no surprises.
But it was when Federal Reserve Chairman Jay Powell took to the podium and alluded to an eventual rate slowdown that we saw a sharp move higher in stocks.
From Powell:
As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation.
The Nasdaq celebrated the most. You can see it erupting after Powell’s comment.
All three major indexes added more than 1% today, with the Nasdaq surging a full 4%.
While Powell’s “slow the pace” comment has a nice dovish ring to it, he did suggest that the Fed could hike rates by the same 75 basis-points in September’s policy meeting (the Fed doesn’t meet in August).
Beyond that, Powell said the Fed can no longer provide “clear guidance” about coming policy moves. Instead, they want to let data determine the course of action.
However, Powell did note that he believes target rates will need to climb to 3%–3.5% by year end.
All-in-all, there were no curveballs from today’s meeting and nothing unexpectedly hawkish in Powell’s press conference. If anything, we saw a foreshadowing of dovishness.
We’ll gladly take this.
Given that we can now breathe a bit easier with this question mark addressed, let’s take a spin around the wider investment universe.
***What are the latest Q2 earnings numbers telling us?
In short, they’re telling us that the Fed’s rate-hikes are working – in other words, the economy is slowing, as is consumer spending.
Take Walmart’s earnings from yesterday.
The retail giant slashed its quarterly and full-year profit guidance, saying inflation is causing shoppers to spend more on staples like food, which leaves less money to spend on discretionary items like clothing and electronics.
This is having a big impact on Walmart’s earnings. Let’s look at the “before” and “after.”
Coming into this Q2 earnings season, the retailer expected adjusted earnings per share (EPS) for the second quarter to be flat to slightly up. And for the full year, it anticipated a drop of only 1%.
But now, management says that adjusted EPS will decline around 8% to 9% for the quarter and 11% to 13% for the year.
That’s a major change.
***If we expand our analysis to the broad market, how are earnings shaping up?
After all, maybe this is more of a Walmart-specific problem, due to inventory pileups from funky supply chains.
From FactSet’s most recent analysis last Friday:
The second-quarter earnings season for the S&P 500 continues to be weaker than normal.
Both the number of S&P 500 companies reporting positive earnings surprises and the magnitude of these positive surprises are below their 5-year averages…
On a year-over year basis, the S&P 500 is reporting its lowest earnings growth since Q4 2020…
Overall, 21% of the companies in the S&P 500 have reported actual results for Q2 2022 [as of last Friday].
Of these companies, 68% have reported actual EPS above estimates, which is below the 5-year average of 77%.
In aggregate, companies are reporting earnings that are 3.6% above estimates, which is also below the 5-year average of 8.8%.
Overall, we’re not seeing the bottom drop out anywhere. At the same time, we’re not seeing positive earnings surprises across the board that we were hoping for.
***One earnings “red flag” to watch
An investor looking for good news could comb through the FactSet report and find this sentence:
Despite the below average performance relative to estimates, the [S&P 500] index has a higher earnings growth rate for the second quarter today relative to the end of last week and relative to the end of the quarter.
The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings growth rate for the second quarter is 4.8% today, compared to an earnings growth rate of 4.1% last week and an earnings growth rate of 4.0% at the end of the second quarter (June 30).
So, that’s good news, right?
Yes, on its surface. But when we look into the nature of this higher earnings growth rate, it points toward one thing…
Huge profits in the energy sector.
It turns out the energy sector is the largest contributor to earnings growth for the S&P 500 for Q2. And this growth is making the overall S&P earnings growth look better than it would otherwise.
How much better?
Well, if we were to exclude energy from the calculation, the S&P would be expected to report a decline in earnings of 4.5% rather than growth of 4.8%.
***These lower earnings and reduced earnings forecasts are having real-world effects
When companies aren’t performing well, they have to cut costs. And what’s one of the biggest costs on a corporate P&L statement?
Payroll.
So, if we’re trying to track the severity of the economic slowdown, it would make sense to track the condition of layoffs and/or official freezes on new hires.
Well, yesterday, Shopify’s stock imploded 14% after the company announced plans to lay off roughly 10% of its entire global workforce.
And don’t think this was a one-off. Below are some of the other layoffs we’ve seen so far this year:
- Peloton – over 2,800 employees
- Re/Max – 17% of its workforce
- 7-Eleven – 880 jobs
- Vimeo – 6% of its workforce
- Tesla – 229 employee cuts
- Rivian – looking at cutting 5% of its workforce
- Gopuff – a 10% cut
- Microsoft – almost 1%
- JPMorgan – over 1,000 workers
- Compass – 450 employees
- Redfin – roughly 6% of total employees
- Coinbase – nearly 18% of workers
- Carvana – roughly 2,500 employees
- Bird Global – about 23% of its staff
- DoorDash – 10% to 15% of its employee count
We could keep going…and so we will!
There’s also Reef, Wells Fargo, Robinhood, Better, Netflix, Noom, Canopy Growth, Thrasio, Food52, Cameo, PayPal, Zulily…
And don’t forget the hiring freezes from Apple, Google, Meta, Lyft, Intel, Microsoft, Nvidia, Snap, Wayfair, Uber, Twitter.
***Despite all this, our government assures us that there’s no recession on the horizon
On Sunday, Treasury Secretary and Chief Gaslighter Janet Yellen said:
This is not an economy that is in recession. You don’t see any of the signs.
Now, a recession is a broad-based contraction that affects many sectors of the economy. We just don’t have that.
Got that?
There aren’t any signs of a recession.
All those layoffs and hiring freezes we just went over?
Those aren’t signs.
The fact that credit-card executives are saying that U.S. consumers are shifting their spending patterns to lower-cost products, while spending more on credit?
Not at all a sign.
Okay, well, what about Mark Zandi, chief economist at research firm Moody’s Analytics, saying that if inflation doesn’t drop significantly, low-income Americans have only six months left of savings?
Or what about the recent plunge in commodity prices – most notably copper, which is seen as a barometer for economic conditions?
Or perhaps news from yesterday that July’s consumer-confidence numbers have fallen yet again – which is no small thing, given that June’s reading was already the lowest in a decade.
Or maybe economist Nouriel Roubini saying the U.S. is facing a deep recession, and those expecting only a shallow downturn are “delusional”?
Finally, what about the “10-2 yield curve,” which is inverted as I write? In fact, its current level of -0.31 is more inverted than the “peak” inversion level of -0.19% in November 2006 that preceded the great financial crisis. Is that a sign?
No. Don’t be foolish. Now, kindly move along and stop asking questions.
***Okay, well, what about the Federal Reserve’s very own estimate from the Bank of Atlanta’s GDPNow tool, which pegs Q2 GDP at -1.2%?
And since Q1’s GDP was also negative, wouldn’t a negative reading in Q2 constitute an official recession?
Well, last week, the White House put out a written statement that lovingly massaged the whole definition of a recession. That would be “two consecutive quarters of negative GDP,” yet the statement concludes:
It is unlikely that the decline in GDP in the first quarter of this year—even if followed by another GDP decline in the second quarter—indicates a recession.
But here’s a question…
If you’re a CEO having to layoff employees because of deteriorating economic conditions… If you’re a consumer having to switch brands because of pressures on your budget… If you’re a low-income American watching your savings evaporate…
Does it matter what you call it?
As a parallel, if you’re getting punched in the face, does it matter whether they’re called “punches” or “gentle taps of endearing affection?”
No. The effect is still a bruised face.
By the way, the Fed’s GDP Q2 Advance Estimate comes out tomorrow. We’ll let you know how the bruising shapes up.
***At the end of the day, the Fed is getting its desired outcome – decreased demand and a slower economy
The question now is: Can the Fed thread the needle and avoid a full-on crash?
We’ve still got plenty of earnings to track that could give us reason to hope. That’s where we’ll be watching for clues.
For now, let’s celebrate the market’s joyful reaction to today’s Fed decision, and cross fingers the gains continue as we finish up the week.
Have a good evening,
Jeff Remsburg
