A tug-of-war: Disappointing earnings vs. peaking rates

DEWITT, Mich. - Nov. 2, 2022 - PRLog -- A tug-of-war may be the most appropriate metaphor to describe last week's price action in the markets. Pulling at one end of the rope were disappointing earnings results from mega-cap tech names and signs of economic activity softening. At the other end was growing hopes for a Fed slowdown and lower bond yields. These opposite forces led to a large divergence between the Dow Jones Industrials Average, which was up 5.7% for the week, and the Nasdaq, which advanced about 2.2%¹. We provide our interpretation and investment takeaways from last week's developments.

Big Tech earnings underwhelm

Investors were paying close attention to corporate earnings last week, as 164 of the S&P 500 companies, or almost 50% of the index market cap, reported results¹. While still only about halfway into the earnings season, several high-profile misses revealed cracks in the theme of earnings resilience that has prevailed so far this year. The spotlight was on mega-cap technology companies, which exert an outsized influence on the markets.  Alphabet, Microsoft, Meta, Apple and Amazon together account for 20% of the index, and, on average, their stocks declined 9% on the day of their earnings release¹. But the tone of the earnings updates was not one-sided. Several companies that rely broadly on consumer spending reported solid trends. Three key themes stand out so far, in our view:

1. Online advertising spending continues to slow, as companies are adjusting their marketing budgets in response to the economic uncertainty, and this is weighing on results of tech and other communications companies. The strength of the U.S. dollar is also trimming earnings for U.S. companies that derive a meaningful portion of their revenue in foreign currencies. Among the 11 S&P 500 sectors, tech is the most affected by currency swings, deriving almost 60% of revenue from abroad².
2. The U.S. consumer is still spending, but less so on goods and more on services. Upbeat earnings from Visa and American Express underscore the resilience of consumer spending despite high inflation and rising interest rates. However, trends appear to vary by income level, with lower-income consumers tightening their discretionary spending. Consistent with the shift in consumer spending patterns, companies that are tied to the reopening of the economy (restaurant, airlines, etc.) are noticing strong demand, with more spending on travel and leisure and less on e-commerce.
3. Strong pricing power is helping support corporate profits. One example is Caterpillar, the industrial bellwether, which noted that it expects price hikes to more than offset rising costs. As supply chains continue to normalize and material and shipping costs fall, some of the headwinds to profits will gradually start to ease.

Sources: 1. Bloomberg, Edward Jones, 2. FactSet