01/17/2023
Investors focus on corporate fundamentals and outlooks as 109 S&P 500 companies report results this week and next
Major U.S. averages rose for a second-straight week, with the S&P 500® Index pushing back within a whisper of the 4,000 level by Friday’s close. In addition, the NASDAQ Composite floated past the 11,000 level by the end of last week, with Growth slightly topping Value. The S&P 500 rose +2.7% during the week, while the NASDAQ jumped +4.8%. Both stock indexes closed the week at their highest levels in a month. The Dow Jones Industrials Average also added to its gains for the year, increasing by +2.0% last week. The S&P 500 is up +4.2% month-to-date, while the Dow is higher by +3.5%. Each is on pace for its best January since 2019. For the NASDAQ, the tech-heavy index is higher by +5.9% this month, also on track for its best start since 2019.
 
Consumer Discretionary (+5.8%), Information Technology (+4.6%), and Real Estate (+4.3%) outperformed the S&P 500 last week, with Consumer Staples (-1.5%) and Health Care (-0.2%) the only two S&P 500 sectors to finish in the red. The 2-year U.S. Treasury yield ended at 4.21%, and the 10-year Treasury yield closed at 3.50%. Notably, the 10-year yield (which is more sensitive to longer-term economic growth and inflation expectations) is lower by 38 basis points since the end of last year. In our view, stabilizing bond prices early in the new year and receding inflation anxiety as of late have helped yields come down from their recent highs. As a result, stock prices have caught a bid in early 2023.
 
The U.S. Dollar Index continued its slide lower, falling 1.7% last week. Since its late September high, the Dollar Index is lower by roughly 10.5%. West Texas Intermediate (WTI) crude jumped +8.3% last week, closing at $79.90 per barrel. A weaker U.S. dollar, China’s push to reopen its economy, and building optimism that a slowdown or recession in the U.S. and Europe this year could prove mild, have pushed crude prices higher in January. Gold finished the week higher by +2.8%, ending at $1923.30 per ounce.
 
Easing inflation pressures and beginning of Q4 earnings season pushed stocks higher last week
 
Inflation and the start of the fourth quarter earnings season were the principal drivers in the market last week, and each provided a few catalysts to help push stock prices higher. On the inflation front, the December headline Consumer Price Index (CPI) slipped 0.1% month-over-month, in line with expectations and below November’s pace of +0.1%. On a year-over-year basis, headline CPI rose +6.5% in December, as expected, and showed the smallest 12-month rise since October 2021. December core CPI (ex-food and energy) rose +0.3% month-over-month and was higher by +5.7% year-over-year. Both measures came in as expected, with the year-over-year rate moderating from November’s pace of +6.0%. Bottom line: Lower gasoline and food prices helped cool headline inflation pressures in December while easing inflation across used-vehicle prices (the sixth consecutive monthly decline), as well as services helped offset upward price pressures seen in shelter. In our view, last week’s consumer inflation report is unlikely to change the calculus for the Federal Reserve. However, the market widely believes that the confirmation of falling inflation pressures provides the opportunity for the Fed to further slow the pace of rate hikes as soon as its next meeting at the end of the month. The CME FedWatch Tool currently shows a roughly 91% chance the Fed raises its fed funds target rate by 25 basis points to 4.50% - 4.75% on February 1. That would mark a step down from the 50-basis point move higher in December and the 75-basis point hikes in each of the four preceding meetings.
 
Also helping add color to the falling inflation narrative was the rise in the Michigan Consumer Sentiment Index, particularly the decline in the survey’s one-year-ahead inflation expectations. January’s preliminary read showed consumer sentiment rose for the second straight month and hit its highest level in nine months. Notably, one-year ahead inflation expectations fell to 4.0%, the lowest print since June 2021, and marked the fourth straight monthly decline. In addition, consumers’ current assessment of personal finances rose to an eight-month high as easing inflation pressures and higher incomes helped improve individual assessments of financial stability. Bottom line: With inflation showing signs of persistent moderation, particularly in areas of high visibility (i.e., energy and food), consumers are beginning to feel better about their own personal finances as well as the path for inflation.
 
From a Fed perspective, data showing continued price moderation in the economy is likely just as important as sentiment data showing consumers believe inflation pressures will continue to moderate in the future. Last week, the Fed received good news on both fronts. And while by no means does last week’s inflation data mean its mission accomplished for Fed officials, investors recognized the improvement and pushed stock prices higher. Finally, on the sentiment front, bullish sentiment in the weekly American Association of Individual Investors (AAII) Survey increased modestly. In contrast, bearish sentiment among retail investors has continued to fall sharply over the last few weeks. With stronger stock performance in January, retail investors appear to be reducing some of their negative bias on future stock returns, which has added a slight tailwind for equities.
 
As earnings season continues, investors are looking for signs of strength
 
Looking ahead, the fourth quarter earnings season will take center stage over the next few weeks. High inflation and slowing economic activity experienced in the September through December period lowered Q4’22 S&P 500 profit estimates materially. From the end of Q3 to the end of December, Q4’22 S&P 500 earnings per share (EPS) estimates fell 6.5%. Thus, we believe analysts set the bar relatively low for S&P 500 companies, with aggregate Q4 EPS expected to decline for the first time since the pandemic. However, with analysts putting in a lower bar for results, investors are hoping companies can hurdle over expectations over the coming weeks and place a needed fundamental tailwind under stock prices.
 
Last week, the big banks kicked off the earnings season, which included earnings per share and revenue beats from a few major institutions. However, building loan loss provisions and calls for a mild recession in 2023 dampened some of the better-than-expected trends in trading results, particularly across fixed income. Positive takeaways from early results out of Financials include rising deposits, credit normalization dynamics, and still solid credit quality among consumers and businesses. With roughly 6.0% of reports complete, blended Q4'22 S&P 500 EPS is down 4.3% year-over-year on sales growth of +3.8%. Over the next two weeks, 109 S&P 500 companies are scheduled to report results, which will likely keep investors’ focus on corporate fundamentals and outlooks. 
 
From our vantage point, the items that could influence stock prices over the coming weeks and related to the earnings season include:
  • The state of the consumer and anticipated demand levels for this year.
  • S&P 500 profit margins have come down versus year-ago levels but remain healthy. Is there a risk of more significant margin pressures ahead? Or is aggregate demand strong enough that companies can maintain their profitability even if growth and activity are slowing? These are the questions investors will likely seek the answers to over the coming weeks.
  • Corporate commentary on labor conditions. What companies have to say about hiring, labor inflation, and the current state of their workforce should provide further color on what thus far remains a very tight employment backdrop. Several large companies have already announced layoffs and/or hiring freezes.
  
2023 is off to a more optimistic start; economic data expected this week will detail the state of the economy
 
Moderating labor growth and wage inflation, a slowdown in the pace of Fed tightening, easing financial conditions, a weakening U.S. dollar, lower energy prices, China reopening, and easing supply constraints have market participants in a better mood at the start of the year. Disinflation traction across the economy and cost-cutting measures from corporations to protect profit margins offer positive factors heading into the fourth quarter earnings season. In addition, the possibility of a shallower slowdown in the U.S. and possibly Europe are other factors helping investors shift away from the market’s more pessimistic narratives. In addition to the market’s focus on earnings this week, December retail sales (Wednesday) should show lower gasoline prices weighed on results. The December Producer Price Index (Wednesday) and December housing data later in the week will likely be other areas of focus for investors as the week wears on.
 
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Sources:
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