US Strategy Weekly: Finally A Focus on Earnings

Earnings season will begin later this week as financial stocks begin to report third quarter results. And for the first time this year, investors seem to be taking a close look at the quality of earnings and earnings guidance. Expectations turned lower for the banking sector after several global banks indicated they plan to raise reserves in anticipation of a weakening economy. Friday will be our first look at how the financial sector managed in the third quarter.

Global Woes

But the economic backdrop for earnings has come under review recently. This week The International Monetary Fund warned that “colliding pressures from inflation, war-driven energy and food crises and sharply higher interest rates were pushing the world to the brink of recession and threatening financial market stability.” Citing new 2023 global growth forecasts from its World Economic Outlook, the IMF said that countries representing a third of the world’s output could be in a recession next year. More disturbingly, the IMF highlighted that financial stability risks have increased, and it warned of disorderly repricing in markets.

Disorderly markets are not new news actually. Instability has already appeared in Britain. Last week the Bank of England expanded its program of daily bond purchases to include inflation-linked debt. It noted a “material risk” to British financial stability and “the prospect of self-reinforcing ‘fire sale’ dynamics” leading to chaos in its gilt market. The Bank pledged as much as 65 billion pounds of long-dated government bonds to allow for a more orderly disposal of assets in the pension fund sector. However, the risk continues, and investors are watching to see what happens when, or if, the Bank of England ends its purchasing program, perhaps as soon as later this week. History has shown how disorderly markets often reflect illiquidity and this instability can ripple through the global financial markets in unexpected ways. This is one of our main concerns for the latter part of the year.

It is important to note that these financial problems emanate partly from the US. The combination of inflation and rising interest rates in the US has driven the trade-weighted dollar to its highest level in 20 years. The Federal Reserve’s new nominal broad dollar index is currently at a 50-year high. See page 7. The strength in the dollar, coupled with rising interest rates, means that other central banks, like the Bank of England, will have to raise their interest rates to prevent their currencies from collapsing. In cases like England, where economic growth is already weak, rising interest rates compound the problem it already faces from higher energy costs, inflation, and a weakening economy. It can become a circular problem that is difficult to solve. Moreover, since crude oil is priced in dollars, energy becomes more expensive to non-US buyers, adding to inflation.  

Exacerbating these financial woes were reports from China that Shanghai and other cities have seen COVID-19 infections rise. Some local authorities began to close schools and entertainment venues, reigniting fears of more shutdowns, slower Chinese growth, and global supply shortages. Again, there are a number of issues outside the US that could have a significant impact on our financial markets in the remaining months of the year. This keeps us cautious.

Focus on Earnings

In terms of earnings, FedEx Corp. (FDX – $152.08) shocked investors last week when it revealed that it was preparing for a further decline in the number of e-commerce packages it would handle in the upcoming holiday season. The stock is down nearly 30% in the last month.

This week S&P Dow Jones consensus earnings estimates for 2022 and 2023 fell $0.63 and $0.25, respectively. Refinitiv IBES consensus earnings forecasts fell $0.38 and $0.86. But the most important news of the week was that the S&P consensus earnings estimate for 2022 declined to $208.12 and is now below 2021’s level of $208.17. This means that if economists are correct about a recession in 2023, investors could be facing two consecutive years of little or no earnings growth in equities. However, keep in mind that earnings in the energy sector continues to be strong, and when excluded from the S&P total, earnings growth in 2022 is already negative. We want to reinforce our view that investors should continue to focus on recession resistant stocks, such as energy, utilities, consumer staples, and special areas like defense-related companies.

Technical Indicator Update

The charts of the popular indices are quite similar this week with all four of the popular indices trading below all their moving averages. This is bearish. However, the one positive sign is the Russell 2000 index which is outperforming the other indices at the moment since the June lows have not been decisively broken. We focus on this small capitalization index since it was an early leader at the market top, and it could also be an early leader at the lows. Conversely, the Nasdaq Composite is the worst performing chart in a major decline. See page 10.

The 25-day up/down volume oscillator can be one of the best technical indicators at defining peaks and troughs. The oscillator fell to an oversold reading of negative 5.6 on September 30 which was a deeper oversold reading than the one seen at the June low, and it was in oversold territory for 10 consecutive trading sessions. This was longer than the oversold reading for six of eight consecutive trading sessions in June. In short, the test of the June lows was unsuccessful by this measure, and the bear market continues. The 25-day up/down oscillator is currently neutral with a reading of negative 2.93 but this is close to an oversold reading. A second oversold reading of greater than five consecutive days would confirm the market has not yet found its capitulation low. See page 11.

The 10-day average of daily new highs is 29 and daily new lows are 547. This combination is negative with new highs below 100, and new lows above the 100 benchmark. More importantly, the 10-day moving average of new lows was 1038 on September 26 and exceeded the previous peak of 604 made in early May. In addition, NYSE the advance/decline line fell below the June low on September 22 – is currently 56,191 net advancing issues from its 11/8/21 high – a negative sign. See page 12.

Jobs The increase of 263,000 jobs in September and a decline in the unemployment rate to the post-pandemic low of 3.5% was enough for investors to believe that the next Fed meeting will result in a 75-basis point increase. However, the number of people no longer counted in the labor force – 229,000 –increased nearly as much as job growth. This led to the participation rate falling 0.1 to 62.3% in September. Data also shows that 5.7% of those no longer counted in the labor force want a job. See page 5. And it is important to note that this is an economy of “haves” and “have-nots.” College educated workers are seeing growth in employment while those with less than a college degree struggle. But all workers are seeing a negative trend in real weekly earnings this year due to high inflation. See page 6.

Gail Dudack

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