Earnings Season: Just Where Are We

There is a lot of uncertainty being experienced in the financial markets these days, uncertainty especially related to what the Federal Reserve is doing or is trying to do and related to how the economy is responding.

Joachim Klement, a market analyst at Liberum Capital in London, very bluntly, presents us with the narrative:

“Downgrades will be a key driver of the first quarter and especially this earnings season.”

We have on one hand, a slowing economy, stubbornly high inflation, world unrest, and a future where it looks as if the Federal Reserve will be raising its policy rate of interest several more times.

But, there are other contributors to the uncertainty, contributors related to the spread of the Covid-19 pandemic, the supply chain problems that arose within this disruption, and government actions all over the world to suspend Russian activities.

Profits in 2023 could fall by as much as 10 percent.

Already, earnings-per-share forecasts coming out related to the fourth quarter of 2022 experienced their biggest downgrade since 2014.

The Federal Reserve forecasts for economic activity in 2023, put the rise in real GDP for the U.S. economy at only 0.5 percent. For 2024, the expectation is for 1.6 percent growth.

This is not a picture that makes one confident about earnings growth.

The Financial Sector

The financial sector, which begin to produce earnings results this Friday, must be carefully watched.

The financial sector results include summaries of what is happening all over the economy, and not just for the banks, themselves.

The largest banks in the United States have already given us a picture of what they see happening in 2023.

The forecast of this group of banks sees the U.S. economy in recession in 2023 along with the growth of real GDP coming in at only 0.5 percent.

The banks are not looking for much loan growth.

The banks are not looking for much deal making.

The banks are not looking for strong trading results.

“Payouts at Wall Street’s largest banks are expected to drop as much as half from last year.”

The year 2023 does not look all that good, except for the fact that these large banks see the economy recovering by the end of the year. The recession, they argue, will be short and not too deep.

We’ll now see how they translate this information into their earnings forecasts starting out this week. JPMorgan Chase & Co. (JPM) will be leading off on Friday.

The Uncertainty

I have written a lot about the uncertainty that exists at this time.

With the Covid-19 pandemic, with the following economic recession, with the supply chain problems along with many other factors, the United States economy seems to be a little more jumbled at this time. Disequilibrium dominates.

In other words, things are not as “ordered” as they usually are going into a recession.

Some areas look very good. For example, the labor area seems to be doing quite well at this time. But, a lot has happened here. Retirements and other changes in work arrangements have impacted sectors all over the economy. The Labor Force Participation Rate has taken a major hit. Working arrangements have changed in many, many sectors of the economy.

The short-run analysis is that the labor markets look strong.

But, are they really?

And, what about small businesses?

Well, it depends upon which small businesses you are talking about.

Can certain small businesses get workers?

What about the tech industry?

In some cases we have never heard of all the layoffs that are going to take place in tech.

And, finance.

And, so on.

The macroeconomic aspects of the situation are not there. It is almost like we have to look at this industry and then that industry, this sector and then that sector.

In my professional career, I don’t believe that I have ever seen such discombobulation of the economy. There just does not seem to be equilibrium anywhere.

Downgrades right now are so dependent upon exactly what industry you are in and where you are located.

The Federal Government

Then you have what the Federal government has done over the past two or three years and to what the Federal government is doing right now.

The Biden administration has continued to pass bills that are increasing government expenditures. It has been truly remarkable how much legislation has been passed raising the government monies flowing into different parts of the economy.

And, this when the Federal Reserve is tightening up on the money stock.

Furthermore, the additional spending has just been adding to the Federal debt that is outstanding.

So, the economy is faced with two impacts from the government: one, let’s break the back of inflation with monetary policy; two, let’s be sure that people are OK by generating cash flows to help those in the economy experiencing pain.

What are investors expected to believe when it comes to trying to understand what the overall policy stance of the government is.

Timing

And, all these things put together creates more uncertainty about when things are going to happen.

As I mentioned above, the largest banks in the country are forecasting that real economic growth will only add up to 0.5 percent this year.

Bernhard Warner writes in the New York Times that:

“There are glimmers of hope after this quarter.”

“If the Fed begins to ease up on interest rate increases, leading to falling bond yields, stocks could rebound in the second half of the year.”

Oh, there might be a pivot in monetary policy something after July 1!

Note that:

“Equity prices are historically 10 times more sensitive to bond yields than they are to earnings.”

Mr. Warner quotes Joachim Klement as saying

“there’s a real possibility we see quite a rally–if not at the end of the bear market in 2023.”

Even the bears are looking for the pivot that will bring back “the good times.”

But, the yield on the 10-year U.S. Government note is around 3.50 and the inflationary expectations built into this 10-year yield is about 2.25 percent.

There are two problems I see in this with Mr. Klement’s optimism.

First of all, the Fed target on inflation is 2.00 percent, so that even if the Fed were to achieve its long-term 2.00 percent inflation goal, this will not create much drop in the nominal yield on the 10-year note.

Second, it is hard to see how much lower the “expected real yield” on the 10-year U.S. Treasury note could drop. Right now it is substantially below the historical levels. Right now its seem to be round 1.25 percent. How, except in a real economic collapse is the “real yield” going to drop much lower?

Personally, I don’t really see a major drop in bond yields coming in 2023 unless the 2023 recession is a very severe one. Then the argument completely changes.

The best a Federal Reserve pivot can achieve in 2023, I believe, is to possibly combat a major collapse in the financial markets.

I don’t see Mr. Klement’s optimism in a real stock recovery in 2023.

So we move into earnings season.

We, investors, need to see, as clearly as possible, what corporations are building into their expected earnings for the year.

Maybe with this information we can get a firmer hold on just what might happen in the next year or so.