No surprises from the Fed… looking at how Q4 earnings are shaping up … what do analysts see coming in 2023? … the disconnect brewing in Q4
Today, as was widely-anticipated, the Fed raised rates by just 25 basis points.The target range now clocks in at 4.50% – 4.75%. The official statement also pointed toward more hikes to come:
The committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.
However, in his press conference, Federal Reserve Chairman Jerome Powell expressed optimism, saying that rate hikes are working, and that the disinflationary process has started.On the other hand, he went on to say that it’s premature to declare victory and he warned against “prematurely loosening policy.” Here are additional selected comments from the press conference:
- Powell says inflation may come down faster, it may come down slower. There’s a lot of reason for caution about the outlook
- Goods inflation is coming down “pretty fast” now
- “We are going to be cautious about declaring victory…. We have a long way to go”
- If inflation comes down faster than expected, that will be incorporated in the Fed’s thinking about policy
This last comment goosed Wall Street.The markets were up as Powell spoke, but gains accelerated when Powell made this point. The gains topped out around 3:45 PM EST with the Nasdaq up more than 2.5%, the S&P up 1.5%, and the Dow up 0.5%. However, by the closing bell, those gains eased to the Nasdaq up 2%, the S&P up 1%, and the Dow flat.
On the whole, Powell spoke out of both sides of his mouth today
For example, he said it is “certainly possible” that the Fed will keep its benchmark interest rate below 5%.He also all-but-told-us that two more hikes are coming:
“We’ve raised rates four and a half percentage points, and we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive.Why do we think that’s probably necessary? We think because inflation is still running very hot.”
Powell went on to add this nugget:
“Given our outlook, I don’t see us cutting rates this year, if our outlook comes true.”
Put it all together, and Powell did sound slightly more dovish today (despite his double-speak), though perhaps not to the extent you would think based on Wall Street’s reaction.It will be interesting to watch the second-wave reaction later this week.
Meanwhile, let’s check in on the other massive influence on the market – earnings
Results are not good.But, they’re not awful. Frankly, the “not awful” is a win. For more details on how the numbers are shaping up, let’s turn to FactSet, which is the go-to earnings data analytics group used by the pros. From their latest update last Friday (so it doesn’t include this week’s earnings):
The Q4 earnings season for the S&P 500 continues to be subpar.While the number of S&P 500 companies reporting positive earnings surprises increased over the past week, the magnitude of these earnings surprises decreased during this time. Both metrics are still below their 5-year and 10-year averages. As a result, the earnings decline for the fourth quarter is larger today compared to the end of last week and compared to the end of the quarter. If the index reports an actual decline in earnings for Q4 2022, it will mark the first a year-over-year decline in earnings reported by the index since Q3 2020.
For additional context, as of last week, 69% of the companies that have reported earnings reported earnings-per-share (EPS) that have beaten estimates. That’s lower than the five-year average of 77%. And if we dig into the size of those “beats,” it’s also underwhelming. So far, companies that are topping earnings estimates are doing so by an average of 1.5%, which is less than the five-year average of 8.6%. Here’s FactSet’s bottom-line on earnings growth:
The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings decline for the fourth quarter is -5.0% today, compared to an earnings-decline of -4.9% last week and an earnings-decline of -3.2% at the end of the fourth quarter (December 31).
So, earnings are coming in worse than analysts expected back on December 31, and even two Fridays ago.
But looking ahead, Wall Street is pricing in rosy conditions
Wall Street analysts appear to be acting as if they believe inflation is all-but-done and there’s no major recession is in the cards.We see this by looking at forward earnings expectations. Frankly, it’s a tale of two halves of the year. For Q1 and Q2 of 2023, analysts expect earnings will decline -3.0% and -2.4%, respectively. Let’s not race past this. We have to contextualize these declines through the prism of “rate hikes.” Remember, there’s a six-to-nine-month lag time in between a rate-hike and when the economy fully feels the economic pain of those hikes. So, the Q4 earnings results, which reflect business conditions from October through December of last year, are a product of what the Fed was doing way back in the spring. And what was that? Well, there was the March hike of 0.25% followed by the May hike of 0.50% (there were no 2022 hikes prior to March, and there wasn’t a Fed meeting in April). And again, what’s the latest estimate for how Q4 earnings will shape up? We just read it from FactSet – it’s -5.0%. Now, as we look ahead to Q1 and Q2 of this year, consider all of the rate hikes that will finally work their way into the economy and impact corporate earnings. Here’s a refresher of the Fed’s hikes since the spring: June – 0.75%… July – 0.75%… September – 0.75%… November – 0.75%… December – 0.50%… February – 0.25% And yet analysts now expect that earnings will decline by only -3% and -2.4%, respectively? Let’s spell out this prediction… The economic impact of vastly more rate hikes is on the way, yet the related earnings fallout won’t be as bad as what we’re feeling now that reflects far fewer rate hikes. I’m having trouble with that logic. But wait until you see the back-half of 2023.
Wall Street’s expectation for earnings growth in Q3 and Q4 2023 is a headscratcher
FactSet reports that analysts expect earnings growth of 3.7% in Q3. That’s certainly optimistic.As to Q4 – get ready… 10.3%. Let’s use logic again… Q4 begins in October. Let’s backtrack the required six-to-nine months to factor in the Fed’s rate hikes. That puts us at now – the December ‘22-through-March ’23 range. And where are interest rates today? Well, as of this afternoon, they just climbed to a range of 4.50% – 4.75%. And where will they be in March? Unless Powell is the greatest poker play ever, they’ll still be at 4.50% – 4.75% – if not higher. So, why are earnings in October going to explode 10.3% when the economic conditions will still reflect, minimally, a 4.50% – 4.75% interest rate environment? Where’s the logic?
A “pause” doesn’t equal a “cut”
I’m tired of this bear market. I want to be bullish and watch my portfolio recover like everyone else.But I don’t understand the bullish enthusiasm for an impending pause in interest rate hikes. Yes, I grasp that a pause would mean no more “steps” before the Fed finally cuts rates. But the critical missing piece is how long the Fed hold will hold rates at their terminal level. And unless the entire Fed establishment are liars, rates will remain elevated for at least a handful of months, if not the entire year. With this in mind, here’s a question… Let’s say you put a plant in a brightly-lit room yet begin to twist the Venetian blinds to darken the room. Day after day, you twist those blinds, depriving the plant of needed sunlight. Finally, you darken the room so much that it’s not bright enough for the plant to grow properly. At that point, you stop closing the blinds. Should the plant rejoice? Will your “pause” in closing the blinds improve the sunlight reaching the plant? Will growth suddenly ensue? Or perhaps is the more important variable how long you keep the room deprived of more light? Bottom-line: What’s going to impact corporate earnings, and by extension your portfolio, is how long the Fed holds rates at restrictive levels.
So, what actually changed today?
To me, the biggest bullish change is that Powell said if inflation falls faster than expected, the Fed will incorporate that into its thinking.That opens the door to the Fed moving in a more dovish manner. But for now, Powell and the Fed appear committed to holding rates at restrictive levels for the entire year. Plus, nothing indicated this is the last rate hike. In fact, as noted earlier, Powell referenced two more potential hikes. But Wall Street is pricing in an earnings bonanza in Q4 that can only happen if Powell is lying his face off, and the Fed is not only about to pause, but begin slashing rates. Based on Powell’s comments today, I don’t see that happening.
Have a good evening,