Peak earnings season, the Fed and jobs

The second busiest week of the earnings season gives way to the busiest week, with 168 S&P 500 companies reporting. 52% of S&P 500 companies have reported earnings so far, with 71% and 68% beating consensus earnings and sales estimates, respectively. The S&P 500 is up 4% over the week and nearly 9% over the past two weeks.

Mixed earnings, which combine actual numbers and estimates from yet-to-be-released companies, remained below forecasts at the end of the quarter, but caught up last week. Six sectors, including energy, industrials, real estate, consumer discretionary, consumer staples and healthcare, are expected to post higher-than-expected earnings on September 30.

The largest mixed earnings increase for the week was in the energy sector, with positive earnings surprises from Exxon Mobil (XOM) and Chevron
). On a related note, regulatory filings showed that Berkshire Hathaway
continued to buy shares of Occidental Petroleum
(OXY) in the last week of September and now owns approximately 21% of the company. A previous piece discussed why Warren Buffett’s Berkshire Hathaway might add to its holdings in Occidental Petroleum. The Communication Services and Industrials sectors were the main negative contributors to week-over-week earnings. Boeing
(BA) recorded a significant loss, which resulted in a substantial decline in the expected earnings growth rate. Alphabet (GOOGL) and Meta Platforms revenue disappointments
(META) weighed on the growth rate of the communication services sector.

Seven sectors, energy, technology, consumer staples, healthcare, utilities and financials, now have better mixed sales estimates than at the end of the quarter. Revenues were boosted by inflation, which made it easier to beat expectations at the end of the quarter against inflationary headwinds for earnings due to rising costs. Sales in the energy sector illustrate the strong rise in energy prices. The only S&P 500 sector with year-to-date stock price gains is energy, though utilities, consumer staples and health care are slowly closing in on the strong rally of the last two weeks.

So far, mixed earnings performance has underperformed expectations at the end of the quarter. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter improved to 2.2% year-on-year, below expectations of 2. 8% at the end of the quarter. Expected earnings growth for calendar years 2022 and 2023 fell again this week.

In addition to an active earnings week, the Federal Reserve (Fed) meets on Wednesday. There is little doubt that the Fed will raise short-term interest rates by 75 basis points (0.75%). The real interest will be in any clues as to how aggressive the Fed thinks it still needs to be to fight inflation. The easing of expectations for hikes in the one-year forward federal funds rate and the resulting declines in yields for two- and ten-year Treasuries likely allowed equities to stage their recent rally. Last week, the first release of third-quarter US GDP showed better-than-expected overall growth at 2.6% after two straight quarters of economic contraction. However, there are signs that economic growth is decelerating. A recession forecast model from Bloomberg Economics has a 100% probability of a recession in the next twelve months.

Although it comes Friday after the end of the Fed meeting, the monthly jobs report will be crucial for the outlook. Consensus expectations are for nonfarm payrolls to rise by 190,000 from 263,000 in September, with the jobless rate rising slightly to 3.6%. Additionally, average hourly earnings are expected to moderate to 4.7% year-over-year from 5.0%. Some weakening in the labor market is essential for the Fed to at least begin to reduce the magnitude of rate hikes.

Despite the high probability of an impending recession, the most economically sensitive cyclical stocks outperformed the most economically resilient consumer staples stocks. The cyclical relationship against commodities is worth watching as it is close to its recent highs in early October, where it and stocks as a whole have flipped before.

Historically, waiting for better financial data to invest in stocks has been a bad strategy. Stocks tend to eventually rise ahead of better economic data, while earnings estimates continue to fall. Additionally, the initial upward movement tends to be explosive.

Time will tell if the current rally is the start of a new bull market or another bearish rally, but it is close to the typical duration and severity of past bear markets. Historically, bear markets have taken about a year to bottom out. The current bear market started in January, so it’s been about three quarters of a year. The typical bear market decline from the top has been nearly 30%. If the October low holds, the S&P 500 will be down more than 25% from its high.

With more than half of companies reporting, overall earnings remain below estimates at the end of the quarter. Actual results have improved and should exceed forecasts by the end of the earnings season, which is a treat. Given the unstable economic outlook, forward-looking business guidance will remain crucial. The Fed meeting and jobs report will determine whether Halloween week offers a trick or treat for investors.

Carol N. Valencia