Earnings come out well, but markets drop

TPP Midweek Trading Update:

The early returns are in, and US earnings so far look better than feared, but any sense of relief is premature at best.

Through the early part of earnings season, about 82% of the companies in the S&P 500 that have reported have beat analysts’ consensus expectations, including both Microsoft Corp. and Alphabet Inc. on Tuesday, and Meta on Wednesday.

That all sounds impressive, but it’s barely above normal. In the past five years, the beat rate has averaged about 76% each quarter, and it has never dipped below 65%, thanks to active expectations management designed to make every quarter look triumphant. But this is no victory, and the first quarter was never truly in question anyway. Instead, investors are trying to assess the probability of a recession in the second half of 2023 or early 2024 after the Federal Reserve’s historically fast tightening of monetary policy.

So far, the results are painting a mixed picture of strengths and weaknesses for companies and the markets they target. For example, McDonald's - a fast food giant with a window into consumers' wallets - beat expectations on metrics including earnings per share and same-store sales.

At the same time, 3M announced a restructuring plan that will cut 6,000 jobs as the company navigates "significant weakness in consumer electronics and consumer retail."

Anxiety about the banking sector continues to lurk after shares of First Republic Bank slumped almost 50% on news of a huge deposit flight earlier in the year.

Some investors' profit-taking ahead of big tech earnings may have also contributed to the stock sell-off on Tuesday and Wednesday said Timothy Chubb, chief investment officer at Girard but Alphabet, Microsoft and Meta all saw shares up in after-hours trading after reporting earnings that topped expectations after the close, boosting U.S. futures.

Some analysts cited revived concerns about an economic downturn, amid anxiety about the budgetary and debt ceiling debate gridlock in Washington, D.C.

"Investors are assessing the extent to which nervousness about what may lie ahead for economies is holding back marketing budgets and delaying purchases by shoppers," said Susannah Streeter, head of money and markets at Hargreaves Lansdown.

Global unemployment is expected to start ticking up (but remained low in the first quarter); excess household savings should start to dip (from still high levels); and the nascent signs of credit distress (which you still have to squint to see) could ultimately turn into rising defaults. All told, the first quarter was somewhat less bad than expected, but it’s yesterday’s news.

Consider the momentum in earnings revisions several quarters into the future.

Earnings-per-share projections are still coming down swiftly for the next four quarters, and until that trend looks as if it’s bottoming, it will be hard to find much blue sky in the outlook.

Of course, Wall Street has been dwelling on recession risks for more than a year now. There’s more negativity priced into the market than there was at the start of 2022, but it’s hard to conclude with any confidence that it’s “enough.”

The average recession zaps about 31% from earnings per share. However, the mean is dragged down by the financial crisis and this recession will be nothing like that.

Still, sell-side forecasts now imply only a peak-to-trough decline of about 3.4% in trailing 12-months EPS, with the bottom in the second quarter. Even in the very short run, the streak of first-quarter earnings beats is no reason to get excited.

In recent history, there’s been no observable relationship between the rate of positive earnings surprises and the performance of the S&P 500 during earnings season. Crazy I know.

In the meantime, the stock market finds itself in the middle of a tug of war. If the economy and profits remain resilient, that will probably spur the Fed to keep interest rates high, and price-earnings ratios will struggle to rebound further.

Conversely, any hint of easier monetary policy will probably coincide with a more dire outlook for profits.

Investors should curb their enthusiasm about earnings surprises in the first three months of the year, because it’s the next four quarters that truly matter, and they’re as uncertain as ever.

This uncertainty has played out in the market this week with most sectors trending downwards with big tech being the only saving grace.

It’s hard to see why anything should go up right now but today we’ll see US GDP followed by a busy Friday giving us GDP and inflation figures from both France and Germany as well are core PCE price index out of the US.

Some good figures and the markets should stabilise but at the moment, any rally feels like a selling opportunity.

The current TPP market bias:

The majority of our traders have just completed an excellent Q1, in what was a very challenging trading climate. Most seem to be starting Q2 in similar fine form.

It seems that the majority of the ‘buy or flats’ and the ‘active’ strategies are timing many of the short/mid term moves fantastically well.

As of right now- our overall bias is one of a SELL variety. It’s worked well so far this week.

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