Consumer Expectations Dive as Earnings Paint Mixed Picture: Apr. 25, 2023

Markets are tilting toward recession mode this morning with equities seeking to pierce important support levels and yields falling simultaneously. On a heavy news day concerning company earnings calls and economic data, corporate earnings didn’t disappoint, but in some instances, lackluster guidance for future quarters weakened investor sentiment. Consumer expectations further weighed on investor sentiment, as weakness concerning business prospects, job possibilities and income opportunities drove a big miss on this morning’s Consumer Confidence Index. New Home Sales did offset some of the pain; however, rising to a 12-month high as buyers acquiesce to affordability pressures.

This morning’s Consumer Confidence read from the Conference Board took a dive, coming in at 101.3, much worse than the 104 expected and the lowest since last summer, when the Ukraine-Russia conflict drove gasoline prices to the highest levels in history. While the Present Situation component of the Index improved slightly in April on the back of modestly higher sentiments regarding business conditions and the labor market, the Expectations component, which depicts feelings about the next six months, continued deteriorating sharply. Readings of Expectations below 80 have typically preceded recessions by less than 12 months. Today’s unpleasant surprise reading of 68.1 didn’t bode well for the markets at a time when investors are hearing some companies report that consumers are becoming increasingly price sensitive.   

This morning’s market activity is being controlled by risk-off investors, who are concerned about future earnings at a time of slowing consumption, sticky inflation and a stubborn Federal Reserve (Fed). The S&P 500 Index is down 0.8% to 4102.75, a whisker away from an important support level at 4100. The small-cap Russel 2000 Index is down a heavy 1.7%, pulled down by regional banks as concerns of a credit crunch intensify at a time of higher debt service costs which weigh on smaller companies the most. The Nasdaq is down 1%, as investor nerves heighten immediately before the first of Big-Tech’s earnings are announced this afternoon by Microsoft.

Bond yields are falling hard at the mid- and long-end driven by a reduction in economic growth expectations. The short-end, however, is reacting less strongly, as a tighter Fed keeps short-term borrowing costs high while debt ceiling concerns mount. Debt ceiling worries are driving a massive variance between yields on the 1-month and 2- to 6-month Treasury Bills of up to 167 basis points, as investors feel safe holding short-term Treasuries for 1 month, but not for 2, 3, 4 or 6 months. The Dollar Index is up 0.5% to 101.84 while WTI crude oil is down 2.5% to $76.78 per barrel as economic uncertainty and Fed rate hike expectations weigh on oil prices but propel the dollar.

New Home Sales in March offered some relief, however, coming in at 683,000 seasonally adjusted annualized units, a 9.6% rise from February. This morning’s Census Bureau report was a 12-month high and elegantly beat expectations looking for 630,000 units and a 1.1% increase. The Northeast and Western regions drove much of the increase, up 170.8% and 29.8% during the period while the Midwest came in at 6%. The South was the only regional laggard with sales dropping 5.4%.

Demand for Goods Continues to Weaken

With the first-quarter earnings season in full swing, companies are reporting that spending for home entertainment and furnishings is continuing to weaken, but in a familiar theme and in similarly delicious soft-drink taste, Coca-Cola and Pepsi are benefiting from an increase in Americans eating out.

With the first-quarter earnings season in full swing, companies are reporting that spending for home entertainment and furnishings is continuing to weaken, but in a familiar theme and in similarly delicious soft-drink taste, Coca-Cola and Pepsi are benefiting from an increase in Americans eating out. Also, this morning, GM reported strong sales in North America and various other markets.

The following companies issued disappointing results:

• Netflix reported first-quarter earnings of $1.31 billion, or $2.88 a share, trailing the $3.53 a share in the year-ago quarter but narrowly above the FactSet consensus estimate of $2.86 per share. The company’s revenue of $8.16 billion was up 4% year-over-year (y/y), but fell short of the consensus expectation of $8.18 billion. The company added 1.75 million subscribers, which fell short of the average estimate of 2.2 million. At a time when consumers are feeling the pinch of inflation, Netflix reported strong growth with its lower-cost subscription option that includes advertising and said its efforts to crack down on password sharing in other countries has been successful. It has delayed introducing the lower-cost service in the U.S. until later in the second quarter of this year to fine tune the offering.
• The Aaron’s Company, which is a lease-to-own and rental business providing appliances, electronics, furniture and other home items, reported $12.8 million in earnings, down from $21.5 million in the year-ago quarter. Its revenues increased 21.5% to $554.4 million due to its acquisition of retailer BrandsMart; however, lower lease revenues, fees and retail sales hurt sales. Costs associated with the BrandsMart acquisition and the decline in lease revenues and sales hurt results.
• UPS reported first quarter earnings of $2.20 per share resulting from $22.9 billion in revenue. The earnings per share (EPS) barely exceeded the consensus expectation of $2.19 per share, but UPS said its revenue declined 6% y/y. UPS said the decline in revenues resulted from deceleration in U.S. retail sales, which reduced the company’s shipping volume. UPS also experienced ongoing weakness in demand in Asia.

While spending for home entertainment and furnishing is declining, the following examples imply that consumers have yet to curtail their overall spending.

• Coca-Cola said its first-quarter profit increased 12% y/y to $3.1 billion, or $0.72 a share. Analysts were expecting $0.68 in EPS. Global revenues rose 5% y/y to $10.98 billion, exceeding analysts’ expectation of $10.8 billion. Coca-Cola said its sales increased the most at out-of-home dining venues. Consumers embraced higher prices that Coca-Cola implemented in response to its own costs increasing due to inflation and the company’s unit volume sales, which is a measurement based on volume of sales rather than the value of sales, increased substantially.
• Pepsi reported first-quarter profit of $1.94 billion, down from $ 4.26 billion in the first quarter of 2022, with the year-ago-quarter reflecting the $3.3 billion sale of the company’s juice division. Its adjusted earnings per share of $1.50 exceeded the Refinitiv analyst expectation of $1.39. Revenues increased substantially from $16.2 billion in the year-ago quarter to $17.8 billion, sailing past the analyst expectation of $17.22 billion. The company boosted revenues by increasing its pricing and had strong sales across channels but mentioned sales at out-of-home dining locations were particularly strong. Pepsi has increased its organic revenue growth guidance for 2023 to 8%, up from 6%.
• General Motors (GM) reported adjusted first-quarter earnings of $3.8 billion, a decline of 6% for the year-ago quarter. Its $2.21 of EPS exceeded the $1.73 in EPS expected by analysts. Additionally, the company generated $39.99 billion in revenue, exceeding the $38.96 billion expected by analysts. GM said it benefited from strong demand for its high-end models and cost-cutting, including an employment buyout program that yielded savings sooner than anticipated. GM is raising its adjusted earnings guidance to a range of $11 billion to $13 billion, which is $6.35 to $7.35 EPS and an increase from its previous guidance of $10.5 billion to $12.5 billion, or between $6 and $7 EPS.

Regional Bank Fears Resurface

Concerns about regional banks were brought to the forefront yesterday when First Republic reported that it was hit by $105 billion in withdrawals, or 40% of its deposits. On an encouraging note, it said withdraws have since stabilized. The decline was partially offset by a group of banks led by JPMorgan pumping $30 billion of deposits into First Republic. The bank said it generated $1.23 in EPS resulting from $1.21 billion of revenue. Analysts expected 85 cents EPS on $1.15 billion of revenue. In the case of collapsed Silicon Valley Bank and Signature Bank, runs on deposits caused the banks to sell held-to-maturity securities at a loss to cover client redemptions requests. However, First Republic Bank reported a held-to-maturity portfolio valued of $31.3 billion, up from $28.3 billion at year-end and $26.8 billion at the end of the first quarter of 2022.  The news of the deposit outflows caused the bank’s shares to drop approximately 30%.

Earnings Outlook

For the first quarter, the S&P 500 is expected to experience a 6.2% earnings decline based on reported earnings and estimated earnings for companies that haven’t reported, according to FactSet. It would be the largest decline since the second quarter of 2020, when earnings plummeted 31.6%. As the Fed continues to provide hawkish commentary and sticks with its opinion that higher rates for longer-than- expected are needed, investors have yet to revalue equities.

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