Weekly Market Update July 28, 2023
Dow Jones Industrial 35,459 +0.7%, S&P 500 4,582 +1.0%
Nasdaq Composite 14,317 +2%, US Ten Year 3.96%, Crude Oil $80.48
This week marked the 2nd week of this quarter’s earnings season – and a busy week it was. In addition to the Federal Reserve’s anticipated 25 basis point hike on Wednesday, the week saw several bellwether names reporting quarterly earnings. As of yesterday, 25% of the S&P 500 constituents reported earnings. Rather than go through each report, we will take a quick look at the overall performance so far and get a sense of how profitability and revenue growth are faring so far.
According to data compiled by JP Morgan and FactSet, of the S&P companies that have reported in the 2nd quarter, 70% beat on 2Q earnings (vs 66% over the past four quarters) and 54% beat on revenue. Earnings growth has been driven by Consumer Discretionary, Industrial and Communication names.
In a normal environment these results that we have seen so far would not necessarily be hailed as the next resurgence of the stock market. However, when you factor in that we have seen 11 rate hikes since March of 2022, and that we have gone from effectively a 0% Fed Funds rate to a 5.5% Fed Funds rate, it is a testament to the resilience of many of the companies within the S&P 500. The chart below shows the price performance of the S&P 500 (light blue line) vs earnings estimates of the companies in the S&P (dark blue line).
If you had polled analysts back as 2022 unfolded and told them we would have 11 rate hikes raising the Fed Funds rate to the highest level in 20+ years, it is unlikely they would have forecast that the economy and company earnings would have remained this durable. This past January a survey by Goldman Sachs of economists showed a consensus expectation of a 65% probability of a recession this year. In fact, at the beginning of the month, a survey of economists by Bankrate put the odds of a recession between now and July of next year at 60%. Foregone conclusion, right? A poll done by Bloomberg on July 24th found that economists now see the recession odds at 50% or less. The point is, the experts just do not know, and you cannot base your investment strategy solely on the expertise of economists forecasting what will happen to the United States economy. If you did, you would have been out of equities and missed a lot of the upside the market has given us this year.
And to add to that, analysts are beginning to raise their net profit margin forecasts for the S&P 500 going forward. In other words, analysts are betting that S&P companies are going to improve profitability despite an environment of elevated rates. What you do not see on the chart below is that the estimated net profit margins for Q32023 and Q42023 are 11.7%, up from 11.1% Q2 2023.
This is not to say that investors should immediately shift all their portfolios to 100% equities. In fact, we continue to believe that investors are well-served, having some exposure to the safe and lucrative returns provided by the short-term Treasury market. But to keep a long-term perspective on the equity positions that you own and in which you believe, sometimes you need to put on some “blinders” to all the noise that comes out during times of stress in the market. If the investment thesis stays intact, stay with the companies you believe in. Because when running the race, you do not want to get distracted by all the other horses.
Have a Great Weekend,
Marshall