By Kelvin Lee
J.P. Morgan and Morgan Stanley kicked off second quarter earnings season last week. With an inverted yield curve, CPI at 9.1% and talks of a 100bps rate hike later this month, it’s hardly a market friendly environment. Here’s what we’re looking for:
This is a market focused on margins. Oil, raw materials and wages haven’t fallen since Q1 and the important question is if firms can pass along these rising costs to their customers. While analysts are still expecting sales expansion of up to 10% growth on the S&P 500, margin forecasts are being cut. With the CPI-PPI spread widening (see our last month’s post) and a still extremely tight labor market, we aren’t convinced complete price stickiness is achievable. Rising inputs costs and interest rates are already eating at bottom lines. Of course, this is going to be sector dependent. Consumer staples will be likely winners as the inelastic nature of their goods mean price pressures are getting passed down to customers. PepsiCo’s second quarter call echoed this as sales remained strong even with a hike in sugar costs. Consumer discretionary, on the other hand, is still concerning as the dismal University of Michigan sentiment print and the unimpressive prime day sales may indicate that customers are tightening spending to focus on essentials. Energy and utilities will unsurprisingly continue to be outperformers as we are just now seeing cracks in the commodity sector and a slight decline in oil prices (we see the possibility of China’s reopening as a massive tailwind for energy prices). For tech, we are keeping our eye on business servicing and cloud focused firms. Subscriber cash flows should remain strong, and material price increases are going to have less effect on software-based companies. On a macro level, we anticipate that the dollar strength will be a theme among Q2 earnings calls. Over 1/3 of S&P 500 companies have international exposure, particularly those with the largest weightings to the index. Euro parity and the USD Yen dollar spot at 137 is going to draw down on top line revenue numbers, another contribution to already strained margin compression.
We will be monitoring earnings as they come across the wire and acutely listening to forward guidance from stressed financial officers. If this is a repeat of last earnings season, then expect harsh investor punishment on negative results and stationary price movements for meeting street expectations.
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