Last Wednesday’s drop in stocks was mostly a function of 1) Disappointing earnings and 2) The natural side effect of the relentless six- week, 15%+ rally in the S&P 500.
Starting with the specific reason ,earnings last week were not good. Numerous firms across different industries including FedEx (FDX), Winnebago (WGO), General Mills (GIS) and Nike (NKE), each warned about either 1) Margins or 2) Revenue. And each of these stocks declined after posting disappointing earnings, and while it’s only anecdotal, the results bring up important points.
Declining inflation (disinflation) and a soft landing (slowing growth but not a contraction) is good for Fed policy but may be a significant challenge for corporate America and negatively impact earnings. The surging inflation of the past several years didn’t result in a large decrease in consumer demand, like it usually does. Instead, consumers kept buying and paying higher and higher prices. The result has been a margin explosion for many companies who realized the consumer will pay substantially more than before and not dramatically reduce demand.
However, now that inflation has peaked and is receding, we are starting to see flashes of the past: Discounts. As firms need to become more competitive on price that will impact margins. Meanwhile, salaries and other labor costs are not declining, and the bottom line is if margins result in disappointing earnings, that could be a surprise headwind in January. I believe the markets will struggle in early January and then move with earnings reports. I still believe those reports will be mostly positive.
Turning to growth, the Fed wants a soft landing but let’s be clear: A soft landing means slower economic growth compared to now. Slower growth typically impacts companies via reduced revenues as consumers “tighten their belts” and we saw some evidence of that in Winnebago earnings and NKE earnings.
Here’s the bottom line: Falling inflation and slower growth are positive from a macroeconomic standpoint because it means lower future interest rates. But from a corporate earnings standpoint, it’s a potential threat and the earnings results from last week confirm we need to watch this closely because if earnings results are too optimistic for 2024 (currently around $245/share for the S&P 500) that will push markets lower as earnings estimates are revised lower. We will see most of that impact by the end of January.
Bottom line, in typical years the price action in the week before Christmas and week between Christmas and New Years can be considered year-end noise and not reflective of anything that’ll move markets in the new year, but I do not think that’s the case this year. I think last Wednesday’s volatility does bring up two issues we need to watch: 1) Earnings disappointment and 2) The total lack of a “Wall of Worry.”
To be clear, I’m not saying I’m bearish to start 2024. I’m not and the underlying fundamentals of the market are still clearly positive. But I do think investors are too complacent with this market as we begin the new year, and I want to make sure we are keeping an eye on both the opportunities and risks as we end 2023 and start 2024.
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