Earnings Update And GDP Is As Good As It Gets

Earnings season moved into the heart of the schedule last week, with 89 S&P 500 companies reporting. Despite the overall earnings picture deteriorating, the S&P 500 rose by almost 2.5% for the week. The better-than-expected fourth-quarter GDP growth did lift hopes that the economy might avoid recession in 2023. According to FactSet, 69% of companies have exceeded earnings estimates, below the 10-year average of 73%. This week is the busiest of the earnings season, with 109 S&P 500 companies scheduled to report.

Blended earnings, which combine actual with estimates of companies yet to report, are lower than forecasts at the end of the quarter and deteriorated again last week. The high earnings growth rate for the industrials remains misleading since the airlines reported a loss in the fourth quarter of 2021 and should post a profit this quarter. While the index-level earnings picture worsened, several sectors saw improving expectations last week. Four sectors, consumer staples, real estate, health care, and materials, are expected to post higher earnings than forecasted on December 30th. The energy sector retains the crown with the highest expected growth rate driven by increased energy prices, with expected earnings slated to increase by 59% year-over-year. On a related note, Berkshire Hathaway
BRK.B
continued to buy shares of Occidental Petroleum
OXY
(OXY) in 2022 and now owns over 20% of the company. A previous piece discussed why Warren Buffett’s Berkshire Hathaway could be adding to its holdings in Occidental Petroleum.

Compared to earnings, the blended revenues improved last week and are now equal to the level at the end of the quarter. Industrials, real estate, consumer staples, health care, and materials have better estimates than at the end of the quarter. Sales in the energy sector illustrate the robust increase in energy commodity prices.

So far, the blended 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 weakened to -5.0% year-over-year, below the expectation of -3.2% at the end of the quarter. Expected earnings growth for the calendar year 2023 declined again this week.

The financial and industrial sectors were the most significant contributor to the decline in blended earnings for the S&P 500. An earnings miss by Boeing
BA
(BA) impacted the industrials, while misses by U.S. Bancorp
TBBK
(USB) and Capital One
COF
Financial (COF) weighed on financials. As discussed previously, margin pressures have become more evident, with sales coming in as expected but earnings disappointing during this fourth-quarter earnings season. This week has some bellwethers reporting results, including McDonald’s (MCD), Meta Platforms (META), Alphabet (GOOGL), Apple
AAPL
(AAPL), Amazon
AMZN
(AMZN), and Starbucks
SBUX
(SBUX).

Outside of earnings season, U.S. economic growth hopes were boosted by a better-than-expected 2.9% GDP growth rate in the fourth quarter of 2022. Unfortunately, the details of the GDP report point to the fourth-quarter growth being as good as it gets for some time and a slower trajectory in early 2023. A larger-than-expected build in inventories adds to downside risk for first-quarter GDP growth as those inventories will need to be depleted before more are produced. Net exports also added more to GDP growth than expected, and that tailwind is unlikely to continue.

Another way to look at GDP data is through real final sales to private domestic purchasers. According to the Federal Reserve Bank of Richmond, real final sales to private domestic purchasers can be defined as “private demand in the domestic economy and is the sum of consumer spending and private fixed investment.” In other words, this measure excludes the impacts of trade, inventories, and government spending, so it does a better job of measuring the activity of the U.S. private sector. By this measure, the economy performed worse than the headline GDP reading indicated. This report was essentially the opposite of the first and second quarters of 2022, when GDP declined, and some argued that a recession had begun. Still, private sector economic growth continued, which argues against that view. Recent data, including retail sales and durable goods orders, indicate slowing economic growth.

The Federal Reserve meets on Wednesday and is almost sure to hike short-term interest rates by 25 basis points (0.25%). The outcome will likely be less captivating to markets than the comments from Chair Powell as market participants are more keenly interested in the path of further hikes to gauge the odds that the fight against inflation will end in recession. Separately, the monthly jobs report comes on Friday. While the details of the fourth-quarter GDP report argue for a more pessimistic outlook for the economy in 2023, the continued resilience of the labor market combined with the health of the consumer could provide optimists with a reasonably strong argument that the economy could break free of this soft spot.

This week starts the busiest of the earnings season. Headline earnings deteriorated again last week and remained below estimates at the end of the quarter. Companies will remain particularly sensitive to forward guidance from companies while the threat of recession in 2023 looms. The Fed is almost sure to hike, but more focus will be on the future path. The monthly jobs report will add to the mix of data as markets try to divine the odds of a recession in 2023.