Three big things you need to know today: First, low quality leadership has returned, something that’s normal after recession lows have been put in. Second, macro themes were muddled in last week’s S&P 500 earnings calls helping explain why the rally has stumbled a bit. Third, earnings related data points continue to highlight near-term softening at the same time that a case for an earnings recovery in 2024 is emerging, highlighting the conflicting cross currents equities are grappling with.
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Now, the details.
Starting with Takeaway #1: Low Quality Leadership Has Returned, Something That’s Normal After Recession Lows Have Been Put In
• Our question of the week comes from our equity derivatives sales team, which reports that they’ve been debating the significance of the low quality leadership seen in the US equity market recently with their clients.
• Low quality leadership has emerged across a number of factors. Low ROE, negative earners, high leverage, low market cap, and high short interest have been outperforming within both Large Cap …
• and Small Cap in recent months.
• We’ve been reminding investors that bursts of low quality leadership are usually seen starting midway through a recession or shortly after one concludes.
• Rightly or wrongly, what recent low quality leadership is telling us is that the stock market has been acting like October was the low associated with the current period of economic challenge.
• We aren’t overly concerned about the idea that short covering has been pushing stocks higher this year. That’s normally the case when markets start the process of climbing off recession lows.
Moving on to Takeaway #2: The Macro Themes In Last Week’s S&P 500 Earnings Calls Came Across As Muddled
• Over the past few days my team and I combed through the earnings call transcripts of the 91 S&P 500 companies that reported last week.
• Overall, the macro messages seemed a bit muddled to us, which (along with renewed Fed angst) helps explain why the rally in stocks seems to have suddenly stalled.
• In terms of the here and now, a significant number highlighted ongoing resilience of the consumer and stabilization in recent consumer trends.
• At the same time, a significant number also highlighted how signs of softness had started to be seen - these were generally outside of the consumer sectors with a fair number in Tech.
• In terms of looking ahead, what’s been getting baked into guidance in terms of the overall macro backdrop varied a bit. For the most part companies seemed to acknowledge the economic softening underway, but weren’t extremely negative with some talking about baking in limited GDP and others talking more directly about a short/mild recession.
• A fair number were also openly talking about when they anticipate recovery.
• On China, we were surprised to find more uncertainty about the reopening than outright optimism.
• FX was still mostly described as a headwind, with a few companies highlighting lessening impacts.
• In terms of cash deployment, most companies seemed to be sticking by their buyback, dividend, and debt pay down plans.
• We did feel like we got a bit more color on M&A than usual, however.
• On the topic of inflation and costs, some companies highlighted ongoing pressures while others highlighted moderating impacts.
• The tone around labor felt a bit more negative than usual, with some companies highlighting how they were addressing labor to save costs, but others indicating that hiring remained a priority.
t investor meetings about how:
e That A Case For Recovery in:
• For the most part, all of the earnings related thoughts we’ve been highlighting over the past few weeks generally remained intact at the end of last week when we updated the various stats we’ve been tracking.
r the most recent quarter and:
• Recovery is starting to show up in the 2024 stats providing a justification for the YTD rally in the stock market.
• Sectors that had been resilient on earnings last year (specifically Energy, Financials, Utilities) have finally started to experience a downward revision cycle,…
• while the sectors that already experienced sharp downgrades to earnings forecasts already (including Tech, Comm Services, and Consumer Discretionary) are starting to see an improvement in earnings sentiment at the margin (the rate of upward EPS estimate revisions is getting less negative).
a sloppy bottoming process in:
• And we continue to remind investors we speak with that stock prices tend to bottom 3-6 months before earnings forecasts do,…
l, and that the downgrades to:
• While we acknowledge that earnings are a problem for the stock market, we continue to think they are not nearly as big of a problem as some of our most bearish counterparts are trying to make them out to be.
That’s all for now. Thanks for listening. And be sure to reach out to your RBC representative with any questions.
