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The First Big Earnings Test for 2023

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Q4 earnings estimates are the lowest since the pandemic … the layoffs keep coming, and not just from tech … the U.S. consumer continues to weaken … but good news from China

We’re on the cusp of the first major test of 2023 for your portfolio.

Q4 earnings season begins in earnest on Friday and analysts are now looking for the first year-over-year decline in quarterly earnings since the pandemic.

Let’s jump straight to FactSet, which is the go-to earnings data analytics company used by the pros:

Earnings Growth: For Q4 2022, the estimated earnings decline for the S&P 500 is -4.1%.

If -4.1% is the actual decline for the quarter, it will mark the first time the index has reported a year-over-year earnings decline since Q3 2020 (-5.7%).

Now, regular Digest readers will recall that last fall, we highlighted how many analysts hadn’t yet reduced their Q4 estimates. Well, as we finally got toward the end of the year, that finally changed.

Back to FactSet:

Given continuing concerns in the market about a possible recession, did analysts lower EPS estimates more than normal for S&P 500 companies for the fourth quarter?

The answer is yes.

During the fourth quarter, analysts lowered EPS estimates for the quarter by a larger margin than average.

The Q4 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for Q4 for all the companies in the index) decreased by 6.5% (to $54.01 from $57.78) from September 30 to December 31.

For context, over the past five years, the average decline for a bottom-up EPS estimate is only 2.5%. If we extend that to the past 10 years, that average climbs only to 3.3%. So, this 6.5% decline is far more than usual.

Analysts’ earnings per share (EPS) estimates for calendar year (CY) 2023 are finally seeing cuts, too.

Back to FactSet:

The bottom-up EPS estimate for CY 2023 declined by 4.4% (to $230.51 from $241.20) from September 30 to December 31.

For context, over the last 10 years, the average decline in the bottom-up EPS estimate for the next year during the fourth quarter has been 1.3%. So, this is a substantial cut.

Now, what’s most interesting is that during Q4, as these analysts were finally slashing EPS estimates, what was Wall Street doing?

Bidding up stock prices.

The S&P climbed 5.5% in the 4th quarter. The Dow soared more than 13%! To be fair, the Nasdaq took it on the chin and dropped about 2.5%.

But overall, why would Wall Street want to pay more for fewer dollars of expected earnings?

If we zero in on the current state of corporate America, current trends don’t seem to support Q4’s run-up in stock prices relative to earnings estimates

The layoffs are coming faster and larger, especially in the tech sector.

From Sunday’s Wall Street Journal:

A new wave of tech layoffs signals how executives in the industry are pivoting from a growth-above-all mindset to protecting their bottom line.

After a bruising 2022 in which companies from small startups to tech giants slammed the brakes on expansion, some of the biggest names in the sector are demonstrating that an era of austerity is only beginning, with expenses scrutinized and moonshot projects abandoned.

Most recently, we learned Amazon will lay off 18,000 workers…  Salesforce.com is going to slash 10% of its headcount… and last week, Vimeo announced an 11% cut in its second round of layoffs so far.

And this morning, we learned Coinbase will slash another 20% of its workforce. This is its second round of cuts.

But it’s not just tech employees hitting the pavement.

Yesterday, headlines reported that Goldman Sachs plans to axe up to 3,200 jobs beginning next week. Last week, it was McDonalds, announcing it will cut some of its corporate staff, though the number isn’t yet reported. Carbon Health also reported new layoffs last week.

And since last fall, we’ve seen slashed headcount from Disney, to Pepsi, to Ford, to Morgan Stanley.

Now, tying back to estimated earnings, all these job cuts might protect profit margins so that earnings remain somewhat strong (for a while). But what about all those laid-off workers? At some point, don’t we have to factor in how their spending patterns will change after being laid off? Which, by extension, will eventually affect corporate profits?

On that note, what’s the latest on the health of U.S. shoppers?

The health of the U.S. consumer continues to erode

Let’s jump to WUSF Public Media:

Personal loans and credit card debt reached record levels in 2022 due to financial pressures brought on by high inflation and climbing interest rates, according to third-quarter data from a consumer credit reporting agency.

Credit balances reached a record-setting $866 billion in the third quarter of last year – and they are expected to keep climbing, the report from TransUnion said.

As you might expect, higher credit card balances are translating into increased credit card delinquency rates.

As you can see in the chart below dating back to 1992, credit card delinquency rates plummeted in the pandemic. So, we’re coming off historic lows. But notice the sharp angle of the uptick in delinquencies – that’s the problem.

Chart showing the credit card delinquency rate shooting up in 2022

Source: Federal Reserve data

Meanwhile, due to stretched family budgets, Americans began to tap their retirement savings in 2022.

From Politico:

A record number of American workers cracked into their retirement savings as inflation soared last year, a dangerous sign that the bulwark amassed by households across two stimulus-flush pandemic years is fading.

Vanguard, which oversees roughly 5 million retirement accounts, found that a growing number of participants in its employer-sponsored plans were requesting loans or seeking withdrawals as inflation rocketed over the last year.

Data from the $7.2 trillion asset management firm found that a record number of savers used their 401(k)s to address immediate emergencies like medical bills or prolonged unemployment.

“Their cash buffers have waned,” Vanguard’s Global Head of Investor Research and Policy Fiona Greig told MM. 

Speaking of “cash buffers waning,” I can add a personal note.

Yesterday, I found this gem in my in-box from my gas company:

Dear Customer,

There’s no easy way to put this: January bills are likely to be higher than usual.

An unprecedented cold snap across the nation in part has caused natural gas market prices in the West to more than double between December and January – much higher than expected.

As a result, SoCalGas residential customers can expect the typical January bill likely to be more than double the typical bill last January, assuming the same amount of natural gas is used.

We’ve said it before and we’ll keep saying it, keep your eye on the health of U.S. consumers. The extent to which they keep opening their wallets is the most important long-term influence on your portfolio.

Finally, in some good news for the global economy, China says “goodbye” to its Zero-Covid policy

From Reuters:

After three years, mainland China opened sea and land crossings with Hong Kong and ended a requirement for incoming travellers to quarantine, dismantling a final pillar of a zero-COVID policy that had shielded China’s 1.4 billion people from the virus but also cut them off from the rest of the world…

Investors hope the reopening will reinvigorate a $17-trillion economy suffering its slowest growth in nearly half a century. 

This is big news on many levels, especially so for resolving global supply chain kinks and for oil and gas demand.

China “getting back to usual” is a great tailwind for the global economy. So, though we stand by our cautious tone earlier in this Digest, this is certainly a positive development we can applaud.

We’ll keep you updated on all these stories here in the Digest.

Have a good evening,

Jeff Remsburg