Quick Thoughts on Q2 earnings
 

Markets have rebounded sharply from the lows of late June on the back of lower than expected inflation readings and better than feared earnings.  While the next few months will be telling from the perspective of how much rising rates and higher than average inflation are impacting corporate performance, we have a few observations that have emerged from this earnings season:

• While the majority of companies beat consensus earnings estimates (~70% at the time of writing), this is lower than the 79% average for the past four quarter, and the earnings surprises were heavily dominated by companies in the Energy sector, which has, unsurprisingly, benefited from >$100/barrel oil prices.  If we back out the Energy sector from the market, the rest of the market’s earnings surprises were well below the average for the past year.
   
• Companies levered to travel and the high end consumer (eg. luxury goods) are telling a very different story from discount retailers like Target and Walmart where their core retail business is being eroded by higher borrowing costs and the soaring cost of food and gas.  The latter are slashing prices and clearing out inventory, which will be disinflationary.
   
• While megacap technology stocks like Amazon, Apple, Microsoft and Google delivered solid reports, the message from them was of a world that was normalizing back to pre-COVID levels rather than slowing outright. The poor performance of social media companies like Facebook (Meta) and Twitter are facing company specific issues relating to the changes in Apple’s privacy settings, which could impeded their businesses going forward.
   
• Disney, and to a lesser extent, Warner Brothers, highlighted a major shift in their businesses from underpricing their products to drive subscriber growth to one focused on increased prices and context expense discipline.  This is just one example of how years of extreme accommodation by central banks was actually disinflationary (the opposite of the intended effect) as it forced companies to under price their products to deliver revenue growth which is what the market was focused on in a “low growth” environment.  An unintended side effect of tightening monetary policy (increased borrowing costs) is it is forcing investors to focus again on profitability, which in turn is prompting companies to shift their focus to increasing prices or passing through inflationary pressure in their cost structures to their customers in order to preserve their bottom lines. 

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