Bears Pounce on Weak Earnings From Wall Street and Main Avenue: May 30, 2024

Equity bears are striving to control the market narrative as lackluster corporate earnings arrive while investors contend with a downwardly revised GDP report. While we’re hearing struggles from publicly traded companies on earnings calls, privately held firms are facing similar margin compression, with this morning’s publication on economic growth featuring the first quarterly decline in overall corporate profits in a year. Inflation data, meanwhile, was also adjusted to the downside, which is giving bond and gold bulls a reprieve in what’s looking like traditional risk-off trading. Figures on the real estate sector and labor market released this morning didn’t mark much of a shift, with the former struggling amidst awful rate and price dynamics while the latter benefits from persistent demand for workers.

US GDP Revised Downward

US first-quarter economic growth slowed to 1.3%, according to this morning’s first revision of Gross Domestic Product (GDP), down from the 1.6% previously reported and fourth quarter 2023’s pace of 3.4%. The adjustment primarily reflects lighter goods consumption and a wider trade deficit. Meanwhile, corporate profits, released in the same report, declined 0.6% on a quarter-over-quarter (q/q), annualized basis, the first drop in 12 months. The revised report also recorded headline and core personal consumption expenditures price indices rising at quarterly, annualized rates of 3.0% and 3.1%. Both were revised downward 10 basis points (bps).

Employers Continue to Hold onto Workers

The labor market was little changed during the previous two weeks from a layoff perspective, with unemployment claims remaining well-anchored. Initial unemployment claims came in at 219,000 for the week ended May 25, near the median estimate of 218,000 and the prior period’s 216,000. Continuing claims arrived at 1.791 million for the week ended May 18, also close to projections of 1.8 million and the previous interval’s 1.787 million. Four-week moving averages did rise slightly for both indicators, from 220,000 and 1.781 million to 222,500 and 1.786 million.

Pending Homes Sales Decline

Elevated borrowing costs and all-time high prices continue to freeze real estate activity, with April contract signings dropping sharply. Pending home sales fell 7.7% m/m and 7.4% year over year (y/y), according to the National Association of Realtors. Last month’s data missed expectations by a wide margin, with economists expecting a m/m decrease of just 0.6%, while March’s results sported increases of 3.6% m/m and 0.1% y/y. The m/m shift can be easily explained by mortgages shifting from a 6-handle to a 7 during the period. Pending home sales lead future existing home transactions, as contract signings occur before keys are exchanged.

Tech Spending Hangover and Weak Consumers Dominate Earnings Calls

Recent earnings reports show that technology companies are generating mixed results while consumer financial malaise is challenging retail sales and causing store operators to maintain a cautious outlook for the remainder of the year. Consider the following earnings highlights:

• Salesforce, a provider of client relationship management software and other business tools, surpassed the analyst consensus estimate for earnings but missed expectations for revenue despite the metric climbing 11% y/y. Salesforce anticipates that its current-quarter adjusted earnings per share (EPS) will range from $2.34 to $2.36 compared to the $2.40 forecast by a consensus of analysts. The guidance caused shares of Salesforce to drop 18% in premarket trading. Salesforce also maintained its previous revenue guidance, which is below the consensus estimate. The company believes many businesses are still adapting to technology purchased during the pandemic while being selective when making new purchases.
• HP Inc.’s revenue surpassed the analyst consensus estimate with commercial clients starting to refresh personal computers in response to Microsoft terminating support of Windows 10 and adding new AI features to its software. HP’s notebook and desktop sales increased 3% y/y, but its printer sales declined. In a Reuters interview, Chief Executive Enrique Lores said the industry is in the early phase of launching personal computers with new AI features. The trend will become more meaningful in 2025. Lores also upgraded EPS guidance for fiscal year 2024 to a range of $3.30 to $3.60. The mid-point of the range exceeds analysts’ expectations. Shares of HP jumped approximately 12% following the earnings report.
• Dollar General reported earnings and revenue that exceeded analyst consensus estimates with its stores attracting increasing levels of foot traffic and capturing market share as inflation-weary shoppers seek bargains. The increased traffic helped offset a decline in transaction sizes and the company’s same-store sales increased 2.4%, surpassing expectations of 1.7% growth. The company maintained its previous guidance, which includes same-store sales growth of 2% to 2.7%. Its share price climbed less than 1% following the earnings announcement.
• Khol’s posted a loss per share of $0.24 compared to the analyst consensus expectation for an EPS of $0.04, causing its share price to tank more than 20% in early trading. For the quarter, comparable store sales declined 4.4%. In a press release, CEO Tom Kingsbury said the combination of the company’s first-quarter performance and “ongoing uncertainty in the consumer environment” has caused Kohl’s to lower its guidance. It anticipates a decline in revenue and its outlook for that metric and earnings missed Wall Street expectations.
• Best Buy’s earnings exceeded the consensus analyst estimate, but its revenue declined more than anticipated. CEO Corie Barry says the industry is likely to begin stabilizing and Best Buy’s quarterly results are likely to improve sequentially, but she cautioned that high mortgage rates, weak demand resulting from strong tech spending during the pandemic, and inflation will challenge sales.
• American Eagle Outfitters’ revenue of $1.14 billion increased 6% y/y to an all-time high, but missed the analyst consensus estimate of $1.15 billion, causing its share price to drop approximately 5%. Earnings exceeded expectations, largely due to the company improving both its product assortment and operations. Finance Chief Mike Mathias told CNBC that the company has a cautious outlook as it waits for interest rate decisions from the Federal Reserve and anticipates “noise” related to the upcoming presidential election. The company believes back-to-school shopping will provide additional insight into sales during the remainder of the year. For the current quarter, American Eagle expects revenue to increase in the high single-digit percentage range, roughly in-line with the consensus expectation.

Investors Rush to Safe Assets

Risk-off sentiments are driving Wall Street today, with market players dumping stocks while scooping up gold bars and Treasurys. Most major indices are moving south with the Dow Jones Industrial, Nasdaq Composite and S&P 500 benchmarks losing 0.8%, 0.6% and 0.4%. There are some glitches occurring with the Dow and S&P indices, meanwhile, with several data reporters reflecting frozen prices (38055.11 and 5241.70) for the indices and replacing them with the corresponding ETFs, in this case tickers DJI and SPY. The small-cap Russell 2000 is up a sharp 1.1% and is the sole gainer among the top US gauges. Sectoral breadth is surprisingly positive, with the selloff concentrated in technology and communication services, which are lower by 1.7% and 0.5%. Treasurys are catching a bid, with the 2- and 10-year maturities changing hands at 4.93% and 4.55%, 5 and 7 bps lower on the session. The dollar is selling off on firmer Fed easing expectations and lighter yields, with the greenback’s index down 44 bps to 104.66. The currency is down relative to all of its major counterparts, including the euro, pound sterling, franc, yen, yuan and Aussie and Canadian dollars. Risk-on commodities that depend on economic activity are getting battered while safe-haven gold is performing well. WTI crude oil and copper are down 1.2% and 2.7% while gold travels north by 0.3%. 

Fundamentals Become Increasingly Important

The unexpected fall in corporate profits was this morning’s most compelling development. While the figure is broad, encompassing large Fortune 500 companies as well as mom-and-pop shops, such as those in my old Queens neighborhood, it has significant implications for earnings expectations for the S&P 500, particularly at a time when we’re sporting heavy profit margins while trading at 21 times forward earnings. Additionally, investors are assessing the likelihood that the Fed is unlikely to cut rates imminently. If corporations fail to meet earnings expectations going forward and growth projections are pared back following decelerating consumption and a challenging cost landscape, valuations and margins are increasingly likely to face mounting pressure. Finally, tomorrow’s personal income and outlays report will provide a shorter-term look at growth, spending, income and inflation dynamics for the month of April. 

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