A little over eighty-one percent of companies have released their third quarter earnings reports according to Bloomberg. Sales and earnings have risen at a modest 2.02% and 2.86%, respectively, as of November 3rd. Those numbers are not impressive, but the underlying details look better. The energy and materials sectors’ revenues and profits were negatively impacted by declining commodity prices. Additionally, a couple large healthcare companies had material, one-time accounting charges that caused reported earnings to be significantly less than the underlying trend. On the positive side, five of the eleven GICS sectors have seen revenue growth above five percent quarter-to-date.
While sales and earnings growth were weak, they exceeded expectations. Sales grew 1.10% better than expected while earnings were an impressive 7.61% ahead of forecasts. Companies often guide down estimates and analysts play along, but earnings clearly beat projections. Numerous companies had very tough year-over-year comps. Moreover, a host of companies entered the year with more inventory than necessary, and this led to sales below final demand in many cases.
As opposed to other quarters where earnings were the dominant factor in stock returns, that has not been the case quarter-to-date. Despite several large companies issuing good reports and solid guidance, they still fell after reporting. Instead, markets have been responding to macro factors. Weaker inflation and unemployment reports have led to a decline in interest rates. Additionally, Chair Powell’s press conference heightened the belief that the Federal Reserve is done raising interest rates for this cycle and will start cutting the Federal Funds Rate at some point in 2024.
NPP does not find the relief rally surprising. Equity markets are entering a seasonally strong part of the year and we expect the rally to continue through year end. Nevertheless, we do not believe lower interest rates alone can form the basis for a sustainable rally. Inflation needs to continue to fall, and monetary restraint must not cause an economic “accident.” A soft landing is still possible and probably the most likely outcome, but the risks of a slowing economy and a recession are greater now that the hard and soft payroll data have weakened. The S&P 500 is now 1.64% above where it was when the third quarter ended. Meanwhile the bellwether Ten-Year Treasury Note, yielding 4.57%, is almost exactly where it ended September despite having traded just above five percent intraday on October 23rd. Intermediate investment-grade credit remains highly appealing in our view. Equities remain attractive too. The average stock has lagged the S&P 500 in 2023. Earnings have consolidated and are likely to move higher in 2024 absent a recession. The risk to stocks in the next couple quarters from higher interest rates has probably fallen, while the risk of a slowing economy has risen. We think maintaining equity exposure near target makes sense for now.