Earnings and Powell. This is the most important week of the third quarter, with the biggest earnings and the Federal Reserve meeting that will set the tone for the entire second half of the year. For the Fed, the problem is that no one is quite sure which version of Jay Powell will appear at Wednesday’s press conference. Will Jay Powell be the fire-breathing inflation killer, or the Powell who sees signs that inflation is easing, or someone in between? For Evercore ISI’s Julian Emanuel, the 9.1% CPI means Powell has to be “resolutely hawkish,” but he will use the strong labor market and retail sales report to argue that the economy can “take it”. In other words, Powell will argue that we have to keep walking, but the hope is that the economy will remain strong. What the bulls desperately want is for Powell to undermine the case for a major recession. But he still can’t. If it speaks to weakening growth and slowing economic momentum (something we saw on Friday with the Flash Services PMI), the bulls will take advantage of that, but don’t want to appear premature. He needs visibility on the extent of the economic slowdown and, unfortunately, Powell won’t be able to tell us on Wednesday. Powell certainly won’t talk about a pause in rate hikes at the press conference, but bulls are already arguing that the Jackson Hole conference (August 25) could be the chance to note that inflation is improving and that the economy is slowing, arguing for a pause in rate hikes later this year. Tech reset Meanwhile, we saw a “tech reset” on Friday. The Flash Service PMI showed a contraction and tech stocks, which had broken out, were sold off. That’s the problem with trying to buy growth stocks prematurely. This summer we will oscillate between the slowdown will be mild or the slowdown will be much more severe. Apple and Microsoft are the biggest earners this week. Everyone fears a slower spending environment and the effect of the strong dollar, but bulls still insist iPhone demand will hold up better than feared. Expect to hear a lot about expense management and bulls heading into a better fourth quarter and 2023. Wedbush’s Dan Ives is in that camp: “As of right now we think iPhone demand is holding up slightly better than expected… That said, The Street is well aware of the weakness this quarter and we believe that ultimately it is looking at past June numbers in the September and December quarters with all eyes on the iPhone 14 production/demand cycle for the fall that follows the path,” he said in a note to clients. last week. Like everyone else, he’s hedging his bets, but arguing that the Street is well aware that a slowdown is coming: “In an unstable macro there will be many casualties as a slower spending environment is on the cloudy horizon of darker storms,” he said. Earnings Still Don’t Reflect Recession The problem with this is that earnings get bogged down in the severity of any recession. The bulls’ buzzword last week was a “mild” recession that would slow but not derail earnings growth. “In a bearish scenario, say a garden-variety type recession, a 10-15% drop in earnings is a reasonable expectation,” Jeffrey Buchbinder, financial equity strategist at LPL, noted in a note recent to customers. He’s right: mild recessions tend to produce modest declines in earnings, which usually reverse within a year or so. Earnings during mild recessions Early 1970s 13% down 15% 2020 13% Source: LPL Longer recessions tend to produce worse results. Earnings during severe recessions 1990s down 37% 2001: 54% 2007-2009 91% The problem is that S&P 500 returns as a whole do not reflect any type of recession, mild or severe. Earnings are still expected to rise 9.2% this year and 8.6% next year, according to Refinitiv. The bulls continue to counter by arguing that this is not an accurate picture. Earnings estimates for the fastest-growing parts of the S&P (technology, communications services and consumer discretionary) have fallen significantly since April 1 (the start of the second quarter), while earnings estimates for Energy have tripled since then. The dramatic rise in energy profits is skewing the earnings picture, they argue. True, but two sectors more exposed to the global economy, technology and manufacturing, are expected to see profits increase by 7.4% and 36.3%, respectively. This isn’t exactly a recession, mild or not.
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