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Good morning. An absolute mess in stock markets on Thursday. The Nasdaq lost almost 4 per cent and the broad indices weren’t much better. Here is what fear does, when mixed with high valuations and higher-than-usual economic uncertainty: following lousy earnings from Facebook parent Meta and Spotify, shares in Snap fell nearly 24 per cent on Thursday before the company had a chance to report earnings after the bell. The earnings were OK, as it turns out, and in late trading the shares rose by 58 per cent. The heroic bounce returned the shares to their level of three weeks ago.
Fourth-quarter earnings season has reduced the market to a nearsighted, adrenaline-addled fear monkey. We try to make sense of things below. A futile task, possibly, but it’s what they pay us to do. Email us: [email protected] and [email protected]
Earnings season so far
Before getting to the gory details, some context. Earnings growth is cyclical. It is plausible that part of the volatility we are seeing reflects the fact that, to an even greater degree than usual, we don’t know where in the cycle we are. To put it slightly differently, because of the distortions of the pandemic, we don’t know much about the trajectory of earnings.
Here is a chart, using data from S&P’s Howard Silverblatt, of S&P 500 earnings over time, and their annual growth rate:
Obviously 80 per cent earnings growth, which we saw in the 12 months that ended in September, is not sustainable. That level is an artefact of using an early pandemic baseline. The comparisons are harder now. The absolute level of earnings is above the long-term trend, too (as indicated, with a near-criminal lack of scientific rigour, by the two red arrows).
But what normalised level and growth rate of earnings are we headed for? Hard to say. So when a company reports slowing revenues and profits, we are left to wonder if we are looking at a return to a healthy normal, or evidence of cyclical slowdown or even incipient recession. In this epistemic vacuum, fears expand.
The problem is made worse when the earnings of the most-watched companies — big, fast-growing US tech companies — depend largely on factors that have little to do with the overall economy, and are weakly correlated to the earnings of the average company. Hence the general despair over weaker-than-expected earnings at Netflix, Meta and Spotify.
Guidance for the first quarter at all three companies was sub-awful. Netflix expects to add 2.5mn subscribers in the first quarter; in last year’s fourth quarter, it added 4mn. (Reed Hastings, co-chief executive: “That’s a low guide, and we think it will be accurate. It’s not sandbagged at all.”) Meta expects first-quarter revenue to grow between 3 and 11 per cent, which would be its slowest quarter ever; last year’s first quarter featured revenue growth of nearly 50 per cent. At Spotify, new subscribers in the current quarter are expected to come in at 3mn; they were 8mn in the fourth quarter of 2021. Yuck.
Do Meta’s results suggest that advertising spending is ebbing — often an early sign of recession? Do the slowdowns at Netflix and Spotify suggest that consumers are retrenching? We think not. Facebook is trying to grow off a base of 2.8bn monthly active users, is unpopular with young Americans, and the company has such a poor brand that it changed its name, and has been hit hard by changes in Apple’s user-tracking rules. This explains the slowdown perfectly well without resorting to recession talk, especially when Alphabet reported advertising revenue up 36 per cent in the same quarter.
Netflix’s subscriber numbers are lumpy and hard to forecast. Here’s a chart:
Yes, March additions look low, but so did, say, those of September of 2020. Reading too much into this would be a mistake. Spotify, for its part, is a big but young business still finding its feet, much like Netflix was five or 10 years ago. In sum, none of these results provide good reasons to worry about what other businesses will deliver.
Zooming out, the totality of earnings don’t look so bad. This summary, from Bank of America’s credit team, includes the results of US companies with investment grade debt:
More than half of public US IG issuers have released 4Q results. Earnings so far have come in 5.4 per cent above expectations at the start of the season, while the sales surprise was +3.0 per cent. The earnings surprise was above the 3.7 per cent pre-Covid average, but well below the 16.6 per cent average since 2Q-2020 . . . we currently track 4Q earnings growth of +24.1 per cent YoY on +14.1 per cent YoY revenue growth.
Translation: earnings for the general run of financially stable companies are coming in just fine, thanks. Don’t read too much into the crackup of a handful of big techs — especially after Amazon and Snap reported solid if not spectacular results on Thursday afternoon.
The results of some economically sensitive companies have included bad omens. One set that gave us pause for thought came from PayPal, which reported on Tuesday. Weak guidance hit the stock. The company blamed a litany of economic headwinds. Here’s Paypal’s chief financial officer on Tuesday’s earnings call:
The impact of Omicron and the effect of inflationary prices combined with lack of stimulus is having an impact on spending and by extension, our business. This impact is most pronounced on our lower income cohorts and has continued into the first quarter. The persistence of inflationary effects on personal consumption, labour shortages, supply chain issues and weaker consumer sentiment have led us to adopt a more cautious outlook.
This is interesting, given that just last week, American Express — whose business, like Paypal’s, depends on payment volumes — crushed analyst expectations on higher spending on its card network that the company said would continue into this quarter. Visa and Mastercard did well, too. Whatever the problems at PayPal, they are not pervasive yet.
We had a very ad hoc look around economically sensitive stocks to, as the kids say, check the vibe. And the vibe was not bad. An unrepresentative smattering of management comments:
Caterpillar — “Underlying demand is stronger than we can currently supply due to ongoing supply chain constraints.”
Qualcomm — “Demand remains strong across all of our technologies and continues to exceed supply. Despite ongoing challenges across the global supply chain . . . supply is going to get better as we get to the second half of 2022.”
UPS — “Early in the [fourth] quarter, volume came in stronger than expected . . . Late in the quarter, volume levels were lower than we expected as Omicron and inventory challenges negatively impacted the enterprise retail sector.”
AMD — “I would say the way to think about pricing is the industry has seen some price increases across the supply chain. And that’s as to be expected given the amount of capacity that we’re all putting on to satisfy the strong demand.”
All those companies are churning out solid earnings results. The economy is changing fast, but for now we see plenty of strength and lots of evidence of sustained high demand, mixed in with a few high-profile face plants. The underlying strength may not stop the sell-off, of course: stocks are expensive, inflation is hot, we are entering a policy tightening cycle, and there is some bad economic data trickling in. And market corrections don’t follow rules or logic, in any case. But earnings, on the whole, are not providing reason for panic. (Armstrong & Wu)
One good read
If Miami — America’s great boom-and-bust city — is having a moment, surely we are near a downturn in the economic cycle?
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