Third quarter earnings season is beginning to wind down, with only 31 S&P 500 companies reporting. 85% of S&P 500 companies have reported results so far, with 70% and 71% exceeding consensus earnings and sales estimates, respectively. The S&P 500 fell by over 3% last week, but that had more to do with the Federal Reserve’s actions than earnings. On a related note, Berkshire Hathaway
Blended earnings, which combine actual with estimates of companies yet to report, remain lower than forecasts at the end of the quarter and held steady last week. Six sectors, including energy, consumer staples, real estate, technology, consumer staples, and healthcare, are expected to post higher earnings than expected on September 30th.
The energy and healthcare sectors had the most significant increases in blended earnings for the week. According to FactSet, positive earnings surprises from Phillips 66
Seven sectors, energy, materials, technology, consumer staples, healthcare, utilities, and financials, now have better blended sales estimates than at the end of the quarter. Revenues have had a tailwind from inflation, making it easier to exceed expectations at the end of the quarter versus the inflation headwinds for earnings due to increased costs. Sales in the energy sector illustrate the robust increase in energy prices. The only S&P 500 sector with stock price gains year-to-date is energy.
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 held steady at 2.2% year-over-year, below the expectation of 2.8% at the end of the quarter. Expected earnings growth for the calendar years 2022 and 2023 moved lower again this week.
In addition to an active earnings week, the Federal Reserve (Fed) met last Wednesday. As expected, the Fed hiked short-term interest rates by 75 basis points (0.75%). The Fed’s statement read dovish as it signaled the likely end of 75 basis point hikes. However, Fed Chair Powell’s press conference was decidedly hawkish as he noted that it was “very premature” to discuss a pause in rate hikes. The markets reacted quickly by raising expectations for more rate hikes, which caused Treasury yields to move higher and put pressure on stocks. The pain was most acute for growth stocks, which are more sensitive to higher interest rates. The longer the tightening cycle from the Fed, the less chance that the economy can withstand controlling inflation without entering a recession.
The monthly jobs report last week was a mixed bag but had enough signs of the start of some softening in the labor market to allow expectations for Fed hikes to ease slightly. Nonfarm payrolls rose by 261,000, exceeding expectations but down from 263,000 in September. The unemployment rate rose to 3.7% from 3.5%. The household survey showed job losses in October. In addition, average hourly earnings are expected to moderate to 4.7% year-over-year from 5.0%. The data wasn’t dispositive and will leave us waiting for the consumer inflation (CPI) report on Thursday, with headline inflation expected to moderate to 7.9% year-over-year from 8.2%. Expectations remain that the Fed will raise rates by another 50 basis points (0.50%) in mid-December, with at least another couple of hikes next year.
Despite the elevated odds of an impending recession and rising yields, the more economically sensitive cyclical stocks have been outperforming more economically resilient consumer staples stocks. The cyclical versus staples relationship remains worth watching as a possible signal that the market is already looking past the likely recession next year.
Tuesday is the U.S. midterm elections, and stocks have historically bottomed in October and rallied by an average of almost 32% in the next twelve months following the midterms. According to Dan Clifton at Strategas, stocks have been positive in the year after every midterm election since 1942.
As to the probable results of the midterm election, the betting odds only place a 9% chance that the democratic party will retain unified control of the government. Setting aside any political biases, this is probably good news, as stocks have historically performed best under the divided control of the U.S. government. Many argue that the market favors gridlock, but one could also note that having to reach a compromise to pass legislation probably helps curb the worst impulses of both parties. Many factors impact stocks and the most important long-term factor is earnings, so politics should fade into the background over a lifetime of investing. More details about the investment implications of the midterm elections are here.
With this earnings season winding down, actual earnings are likely to remain below estimates at the end of the quarter. Given the unsettled economic outlook, forward guidance from companies will remain crucial. Despite the Fed’s dovish statement signaling the likely end to 75 basis point hikes, Fed Chair Powell was decidedly hawkish. The markets reacted quickly by raising expectations for more rate hikes. This week’s CPI report will provide another data point to adjust Fed expectations. The midterm elections on Tuesday typically provide a positive catalyst for stocks over the next year.
Read More: Powell Sends Stocks Reeling Despite Decent Earnings With Midterm Elections Coming