This week, most market participants will focus on one of two things. Some will be poring over the Consumer Price Index (CPI) and Producer Price Index (PPI) reports, due out on Wednesday and Thursday respectively, trying to get an idea of how much inflation is moderating . Others will look less at the raw data and more at its impact on Fed policy decisions, focusing on the many speeches expected by FOMC members this week and looking for clues about how they are currently thinking. Both of these things are important to the market’s role as a forward discount mechanism, but we shouldn’t lose sight of one historical data this week that is arguably more important right now: earnings.
In times other than exceptional ones, it would be foolish to even suggest that earnings were in danger of being overlooked or undervalued. The most fundamental driver of a company’s value is how much money it makes (or loses in some cases), so an earnings season is always a big deal. Right now, however, the market is only concerned with trying to predict the future with regards to inflation and its impact on interest rates. That’s understandable, but ultimately these things only matter to investors to the extent that they affect stock prices, and so far, their impact has been like many things in the post-pandemic world: unpredictable.
After sixteen months of adjustments, the Fed Funds rate went from effectively zero to just over five percent, a massive move that, in theory, should have resulted in at least a severe slowdown in economic activity, if not an outright one. own recession. Things have slowed down, but not enough to derail the market, with all three major indexes up year-to-date. One of the main reasons is that rate hikes and cash withdrawals have not had a massive impact on earnings. They are down, but not to the extent that those who watch inflation and the Fed would have us believe in December. And yet, those same people are still telling us that we should focus on those same things during a week when the earnings race begins.
We’d all probably be better informed about the potential market direction if we saw Fed member comments and this week’s inflation data for what they really are, just two of many factors potentially affecting earnings, and understood that it’s those earnings and forecasts for future earnings that ultimately drive the markets. Yes, earnings reports look back three months as traders try to look forward, but they show the actual rather than the theoretical impact of interest rate changes. And if we know one thing about the post-pandemic recovery, it’s that a lot of theory and conventional wisdom has been turned on its head. In theory, unemployment should have soared after 15 months of rate hikes, but the unemployment rate last month was 3.6%, exactly as it was in March 2022, when the Fed started hiking rates.
Of course, this isn’t your father’s interest rate cycle, nor is it even a conventional period in terms of earnings. Despite what seemed like a strong consensus view that a recession was coming, if not already, and with analyst revisions to second-quarter earnings cutting expectations a chunk from expecting a 4 .7% in March to -7.2% today, an above-average number of companies the S&P 500 has issued positive guidance this quarter.
One would think that something had to give there, and with an average of about 70% of companies exceeding expectations for EPS each quarter, the more likely outcome here is that companies continue to confuse economists and analysts and, in doing so, mislead demonstrate once again that the greatest quality of the US economy is its resilience, both in terms of consumer behavior and corporate profitability.
If the impact of rate hikes has turned out to be so unpredictable, why are so many focusing so much on them rather than their actual impact as shown in earnings? I wish I could tell you, but so far it beats me. What it will do, however, is create an opportunity for investors who understand what’s going on. If this week brings “bad” news on inflation and interest rates, which seems very possible, and an initial trend in earnings towards exceeding expectations, as seems all but inevitable based on history, we could see a market down despite relative earnings strength . This, dear reader, is a short-term buying opportunity, even if you still believe that rate hikes must inevitably negatively impact the economy and markets sooner rather than later.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
