March 01, 2023
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March 2023 Market Commentary
March Market Update 2023
As we close out the earnings season for the fourth quarter of 2022, I thought it would be helpful to provide an update on how companies are doing in the current economic environment of high inflation and rising rates.
With 94% of the S&P 500 having reported, here are the results:
- 68% of companies beat consensus earnings estimates, which is below the 5 year average of 77% beating.
- On average, companies beat their estimates by 1.2%, which is also worse than the 5 year average of 8.6%.
- 66% of companies beat revenue estimates, that is less than the 5 year average of 69%.
- On average, companies beat their revenue estimates by 1.9%, which is the same as the 5 year average of 1.9%.
Also worth noting is that earnings overall were 4.8% below the same period a year ago, even as revenues were 5.4% higher than a year ago. After tax profit margins 11.2%, below the 5 year average of 11.4%.
The takeaway here is that even though US and global economic growth is still positive, the fourth quarter of 2022 was the start of a decline in corporate earnings that analysts expect will continue for at least two more quarters. Thus far the earnings declines have been modest, which is why stocks remain relatively resilient.
The market also thinks that the economy is strong enough to avoid recession in 2023. This is based on the strength of the consumer who continues to spend, and a strong jobs market that provides an opportunity for most people who want to work, to have a job. This is especially so in the services sector, where recent inflation data shows consumers are still willing to pay up in spite of higher prices, at least for now. Results from Home Depot and Walmart show that consumers are spending less on hard goods or big ticket items like home renovations, and are shifting to spending for experiences such as travel, restaurants and bars. Since the consumer represents about 2/3 of the US and Canadian economies, we will need to have the consumer continue to spend in order to avoid a recession in 2023, which is the base case for many economists.
In other developments, January’s inflation data was higher than expected, in terms of CPI as well as PPI (manufacturers inflation) and PCE, the Federal reserve’s favorite measure of inflation. This has caused the market in recent weeks to re-think it’s expectations for interest rate increases by the Federal Reserve in the US. Current expectations from the CME FedWatch indicate a 63% probability that Fed Funds rates will be at or above 5.25% this year, that’s up from a 31% probability a week ago. This is why we have seen growth stocks slump recently after a very strong January rally. In other words, stronger than expected economic and inflation data is forcing the market to reset it’s expectations for future rate policy, causing the market to pull back.
On a brighter note, corporate bonds spreads, are behaving well, with the premium bond investors demand for taking on corporate debt risk remaining low by historical standards. They are certainly not telling us the market is worried about corporate loan defaults. That’s because the bond market is, so far, confident the corporate earnings and cash flows will remain strong over the next 2-3 years.
January saw a strong rally in the markets as growth stocks rebounded from over-sold levels in December. But most gains have been in unprofitable or barely profitable technology names and growth stocks. Breadth was poor, staples, utilities and defensive names did not participate. This was most likely short covering by hedge funds who are now getting more bullish, and an over-sold tech sector after December’s tax-loss selling.
History shows these types of rallies usually run out of steam in February and March. Most institutional investors are skeptical about the durability of this rally. We could see a pullback in the months to come, as the January rally fades in February and March. One should remain cautious in the near term and use pullbacks to begin to put money to work in high quality companies that pay a dividend.
In spite of the January rally, the S&P 500 is flat at about 4000 over the last 3 months (since November) while earnings estimates for the index are down 4% for all of 2023 vs 2022, and down 7% for the first quarter of 2023 vs Q1 2022 (from prior estimates in November). This looks like a disconnect that requires explanation. Firstly, perhaps the markets have already discounted Q4’s bad quarter and the first two quarters of 2023 earnings revisions lower. The second explanation might be that the market thinks the current quarter (Q1, 2023) market earnings of about $51/share represents trough earnings for 2023. This translates into $204/share annually, and applying a multiple of 20x gives you a S&P 500 valuation of about 4000, which is about where we are today. This is a rich valuation however, if the economy falters, and so we could see further modest downside in the coming months before the market ultimately turns higher on recovering earnings in the second half. Let’s all keep our fingers crossed.
As always, if you would like to talk about anything mentioned in this letter, or would like to review your portfolio in light of the inflationary cycle we are now in, please call or email me. We would be happy to arrange an in-person meeting (or via telephone or virtual) to review your portfolio, or discuss any matter related to your financial well-being.
Gordon Forsey Advisory Group:
Gordon Forsey P.Eng., MBA, CIM, FCSI
Portfolio Manager, Sr. Wealth Advisor
Tel: 902-420-6203
Andreas Demone BBA
Client Associate
Tel: 902-420-9624
Terri MacPhail
Client Associate
Tel: 902-420-8263
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