META - Earnings Season With Steven Cress - Pay Attention To Sales Beat

2023-04-21 15:30:00 ET

Summary

• Head of Quant Strategies Steven Cress joins Managing News Editor Kim Khan to discuss how quant ratings can help investors during earnings season.
• Large banks are the place to be while mortgage-backed REITs have been awful.
• Some mega-tech stocks have seen enormous returns after selling off sharply in 2022.

Listen to the podcast embedded above or on the go via Apple Podcasts or Spotify .

Head of Quantitative Strategies at Seeking Alpha Steven Cress joins Managing News Editor Kim Khan to discuss how quant ratings can help investors navigate the market during earnings season. Why large banks are the place to be while mortgage-backed REITs have been awful (3:00). Some mega- tech stocks have seen enormous returns after selling off sharply in 2022 (5:15). Quant strong buys (10:00) and skepticism about a soft landing (17:00).

Recorded on April 20, 2023

Transcript

Kim Khan: Welcome to Seeking Alpha's Investing Experts Podcast. I'm Kim Khan, your host for this episode. I'm joined by the indefatigable Steve Cress, who is Head of Quant here at Seeking Alpha. Welcome, Steve.

Steven Cress: Thank you so much for having me today.

KK: It's great to have you, and it's an exciting time. So we've got earnings season really gaining traction. It looks like the numbers have been holding up well enough for the broader markets so far, Tesla ( TSLA ) notwithstanding, on the day we're recording this today, which is kind of weighing on growth. But I was looking at a note from Morgan Stanley strategist, Mike Wilson, to start the week. He had a great track record last year. And he made a great analogy using probably my favorite book, The Sun Also Rises by Ernest Hemingway. And in it, the undischarged bankrupt character, Mike Campbell is asked how he went bankrupt. And he replies, two ways, gradually, and then suddenly.

And that's kind of how Mike Wilson's seeing the markets work recently, especially in respect to earnings, that we've seen a gradual erosion of ETF estimates, but things could get pretty sudden in a hurry. He says that revenue growth could be disappointing over the next few months and quarters, and that's going to ratchet down some estimates. So if we take that caution in mind, and we want to know, for our listeners, how quant rating can really help investors who might be tempted to ditch out to equities after this run we've seen here today and look for the returns that we're seeing in cash and bonds right now.

SC: Well, again, I appreciate you having me here today. And regarding Mike Wilson, I will share with you that I used to work at Morgan Stanley for 13 years, and actually used to sit right next to Mike Wilson on the trading floor for a number of years. So he is a terrific guy. And he is an excellent strategist as well.

I think I'll start off with the part of your question that has to do with earnings season. As you mentioned, it looks like the results are holding up. I would say it's the very, very beginning of earnings season. And this is largely being seen in the results from the mega financial institutions, typically fully integrated banks and insurance companies, they should do well when rates are higher and in the face of inflation. And I wrote a couple of articles going back well over a year ago, that banks would be a good place to be, and insurance companies larger ones.

The stocks have been pretty mixed to down. But I think now with results coming out, after this period of inflation, people are seeing indeed, large banks are the place to be a large insurance companies. They have multiple products that can offset any reduction in loan demand. And then with regards to earnings, we are seeing some solid earnings. However, I don't want to say in the financials, that is really the Tier 1 institutions.

When we look at some of the regional banks, particularly when we look at mortgage-backed REITs, they have traded very, very poorly. And we've seen a couple of scares with some of the smaller banks across the United States and the mortgage-backed REITs have been awful. We also have to take into consideration that year-over-year growth figures are heavily skewed, more than we see have seen in a long time. One way or another, they're being impacted by the war in Ukraine or by COVID payback. So this is having an impact right now on these quarterly results.

As of yesterday, the earnings scorecard showed 51 companies out of the largest 600, reporting in the U.S. for the fourth quarter. This is really interesting. The beat rate for this group on earnings per share, it's 78% of the companies. Now it's not a lot of companies, it's only 51, but that's a pretty heavy beat rate.

What I said that before is that we're largely seeing this out of financial institutions, and that's really representing more than 50% of the results that we've seen. This is the part that's really unnerving. The sales or revenue beat is pretty disastrous. It's actually come in at 61%. And this is well, well below trend. As I mentioned, this is with about 50% of the companies reporting are just showing really poor sales figures. So the earnings beat is really being aided by financials. And outside of financials, it's not really looking great.

In regards to Mike Wilson, going back to him, as I mentioned, he's an excellent strategist. And really, I remember going back in 2021 when Bloomberg was serving most equity strategists, he was really one of the few guys at the time that was looking for a correction in 2022. But really a good year prior to 2022 he was calling for this. And right now his near term bearishness, it comes down to a pragmatic view on that.

A fair amount of his negative sentiment on the economy, I would say was baked in over 2022. It's discounted to the stock prices. Having said that, last year, many sectors, but specifically tech and consumer discretionary, really sold off. And as we've gotten to the first quarter of this year, we've seen a bit of a reversion to the mean. Especially with the mega tech stocks, we have seen some enormous returns. And that's because they sold off so sharply in 2022.

Just by example, like NVIDIA ( NVDA ) year-to-date is up 91%, Meta Facebook ( META ) is up 79%, Tesla ( TSLA ) is up 46%, Apple is up 29%. So these returns for, like these enormously large companies is incredibly unusual. And again, I think it's a bit of a reversion to mean that we experienced. Mike's feeling is that, we did see a fair amount of stock sell-off last year, but it's not over yet. Inflation tends to be a very sticky substance, and it's very, very hard to shake. And his feeling is that the earnings recession is in a cycle where we're probably at the beginning of the end of the cycle.

Without question, earnings weakness is still to be expected in many industries. And I think over the coming weeks, this is going to become really evident as companies continue to report. No question, we are definitely already seeing this in sales figures. What this all means is that investors need to be careful, and they should use all available tools to determine what companies are profitable and what companies are proven winners.

So this brings me to SA Quant . Seeking Alpha Quant can really help provide investors with an instant characterization of stocks profitability, or earnings revisions compared to its peers. And in this type of market that's what you really want to look at. You need companies that are -- have high quality, that are profitable, and SA Quant has a grade for overall profitability. So you can see it's either an A+ or an F, which will give you that instant characterization.

And one of our proprietary Factor Grades that we use is earnings revisions. So we actually measure how many analysts are upgrading, or I should say, how many analysts are revising their earnings estimates up or down compared to its peers. So it's a relative number. These rates are all relative. They're not absolute. So that gives you an instant characterization of how the company's profitability looks, or their EPS revisions look versus the sector.

Profitability is an essential metric for a stock, because it indicates the company's ability to generate earnings and grow its business over time. EPS revisions, as I mentioned, those are Wall Street analysts that are revising their estimates, and the EPS revisions grade, it measures an analyst's revisions for that stock, as I said, compared to the overall quantity of revisions for that sector.

So these are very specific grades that we're looking at. But again, saves investors who are performing research a tremendous amount of time, as they try to look at -- you can't look at all the Wall Street earnings reports. And we do that for you and we put it in the summary one specific grade. And if you look at all the profitability metrics for a company, it's quite difficult, especially if you want to compare it to the rest of the sector. And again, we reflect that all on one single grade. Hope that answers your question.

KK: Absolutely. Yeah. I just wanted to ask you quickly, before we go into some specific names that you've talked about, and written about this week. Just on the earnings feature overall, I mean, in your opinion, are we kind of over any fears of a systemic event, that SVB ( SIVBQ ) probably will stop [ph] to the number one list of worries in most traders’ minds for a while, but has now kind of receded or -- and then also, do you think now, the latest top of mind one, which seems to be kind of a credit crunch from lending institutions is something that we should be keeping in mind?

SC: I think it's sort of just like a giant blur into uncertainty. Whether it's a systemic problem, or it's a forecasted problem, these are definitely issues that are on the minds of investors. And even yesterday, despite the year-to-date performance that we've seen that of technology and consumer discretionary, I've definitely seen periods over the last couple of months, where all of a sudden, we have like a huge rally in like utilities and consumer staples and real estate REITs that pay high yields. And we saw that yesterday as well.

So I think there is a tremendous amount of uncertainty there. And I think as we go through earnings, the uncertainty will begin to -- investors' anxiety will begin to rise, and then we'll begin to project, okay, these are known uncertainties. They may become real uncertainties, or could lead to systemic risks that are out there. So I think we're in for a lot of volatility over the next couple of months.

KK: All right. Excellent. So I mean, we're just going to go right into a few specific names right now. And you had an article that has the kind of headline that I as a news editor, love it straight to the point, Top Five Stocks for Earnings Season . Can you just give us a brief overview on the names you chose and a couple of reasons why they stood out on our quant rating system?

SC: Absolutely. I selected five Seeking Alpha Quant strong buys on the basis of the largest amount of upward EPS revisions. I looked for strong reviews and strong EPS growth and solid profitability. And I’d say, along with these factors , I also look for value and momentum. So collectively, I look for these factors. And we look for what's strong and what's weak. And in this particular market, as we are coming into earnings season, I fully expected to see a lot of differences that were dramatic in terms of companies beating and companies surprising.

And as I mentioned, I’m not surprised at all that the Tier 1 financial institutions have done well. And I will not be surprised when we see some of the consumer discretionary companies or industrial companies, anyone who's sort of -- at the -- has higher interest rates eating into their margins, I expect those companies to do pretty poorly.

So first and foremost, I really wanted to demonstrate that there are companies out there by using our screens and our ratings that you could easily find companies where there are very strong upward EPS revisions. So going into this kind of market, I want profitability, and I want companies where analysts are expecting them to do better than expected, and hence they're actually increasing their earnings estimates. And that's why I identified these five stocks.

KK: So the names we have, we’ve got Allegro MicroSystems ( ALGM ), Salesforce ( CRM ), Par Pacific ( PARR ), Fastly ( FSLY ), and Marathon Petroleum ( MPC ), all of which have done better than the S&P so far year-to-date. S&P up about 8.5%. So why did these specific ones stand out?

SC: Yeah. So again, sort of out of those five core factors that are collectively strong. But additionally, they've had, in the last 90 days, a lot more analysts revising estimates up than down.

And starting with Allegro that actually has a quant ranking of number one in its industry out of 68 companies. And the number of analysts that have upgraded in the last 90 days are six analysts up and zero down. This is a semiconductor stock that's really been able to capitalize on the demand for electric vehicles. So obviously, outside of Tesla, you have every major automotive company in the world now pouring a lot of money into EVs. They may not be doing well, but this company is definitely benefiting as a result of it.

My second pick, which was Salesforce , this is incredible. They have, in the last 90 days, 37 Wall Street analysts have upgraded above their earnings estimates and zero have taken it down. So they're really, really positive on earnings going forward for Salesforce. This stock ranks number 4 out of 213 in the industry based on our quant ranking. And what really sticks out to me in this company is that they have tremendous profitability and gross margins of 73%. They also have $7 billion in cash from operations, which offers a huge cushion.

My third pick was Par Pacific Holdings. This is an energy company. And its quant ranking is number 2 out of 23 stocks within its industry. They had an excellent fourth quarter, and they've already crushed their previous results. The company is -- it's got a bit of diversification to it. And we've seen a number of energy stocks sort of pull back, I guess, in January and February. But this company's results, believe a lot of them are being driven by the reopening in China and also jet fuel demand, which has increased dramatically. And it's coming through to their earnings and it's been coming through the last couple quarters. And based on what analysts are looking for, it's going to continue to happen.

The fourth pick was Fastly. This company ranks number 2 out of 26 in its industry and it experienced 13 upward revisions and zero down revisions. And they both have a superior network that, I guess, they delivered just a lot better than their competitors. And that's coming through in their numbers. They have a lot of advanced capabilities through their diversification. And again, that's really helping their revenue streams. This is a cloud-based stock. And cloud-based and AI stocks have done very well. They pulled back in the last couple of weeks. So I don't look for any weakness definitely to add shares in this company.

And the fifth and final one is Marathon Petroleum, which is dominant in its place and its dominant in terms of our quant rankings, too. It ranks number 1 out of 23 stocks within its industry. Analysts - despite what the stocks have been doing, analysts have been very positive on this company. And there have been 17 analysts in the last 90 days that have taken earnings revisions up and zero have taken down. And this company within energy, they focus more on refining products, and they're posting some of the highest seasonal demand that they've seen in the last five years.

So those are sort of the five picks that again, really being led by analysts' upward revisions and crushing on their results.

KK: That Fastly is up 100% year-to-date, does that give you pause at all, or are you confident with the revisions that you're seeing?

SC: The - in terms of the valuation for the company, it is bordering somewhat on the expensive side versus the sector. So that tends to give me a little bit of pause. And the growth, I'd say is above average for the sector. It's not the highest in the sector. So something like that could give me a little bit of pause.

But in terms of the analysts view on this stock, they remain very positive. It seemed like in this kind of environment to have 13 analysts in the last 90 days upgrade. And in the last quarter, the company handily beat on EPS revisions, and they beat on revenue as well. So analysts are quite confident in this. So if I take that analyst confidence, along with the Factor Grades that we have, they may not be the best Factor Grades, but we have the analysts' conviction, I'll take it.

KK: Just want to remind our listeners, too, that as a Seeking Alpha subscriber, you can screen for any of these quant rating categories and come up with your own list of picks for going into earnings season, for any kind of news events. It's one of the great tools we have on the site and a big advantage for our subscribers.

I'd like to move over a little more macro now, because you did address this in your article this week as well about the probabilities of a recession. And that's a base case of most of the Wall Street sell-side, but there are a few notable exceptions, like Goldman Sachs is still saying, well, 65% chance of actually avoiding recession in 2023. So what makes you skeptical about a soft landing?

SC: What makes me skeptical, I guess, this could put me a bit into the Mike Wilson camp is that we still have to deal with erosion in earnings from higher interest rates, and also the stickiness of inflation. And even though we’ll see in the press that inflation is starting to come down in certain areas, that is true, but in other areas, it takes a lot longer for inflation to come down than most people would like. And we're still higher rates is -- higher inflation.

So what does that mean? That means higher rates means less profits for most corporate borrowers, and this eats into their earnings and profits. Higher rates, it means higher mortgage rates and that means lower new housing units being sold. And it also means, as you have to -- if you have an adjustable rate mortgage, and it's gone up, you have less discretionary consumer spending, and also non-essential items that you may have bought, which comes under discretionary consumer spending.

That slows down, and also means higher credit card rates. So that, again, equals less discretionary, and often less consumer staples spending as well, and also means higher auto financing. And that leaves a lot less on the table for both corporates and individuals where corporates have fleets and the rates you get these vehicles goes up through leases. Individuals, I know the car that I have, just three years later, I have to get a new car…

SC: Sure. All right. so I'll go through that. I'll start with a higher auto financing. Also, we have higher auto financing, which is -- it's just a tremendous impact from higher rates. And that leaves a lot less on the table for both corporates and individuals. And I know, personally, I have to get a car again. It's going into this third year, which is not a big difference that I just looked at the same exact car, no new additional features. And to get that same exact car, that's going to cost me $175 more a month than it did previously. And that really bites into your pocket.

Also, you've probably seen in the press recently, especially from some of the large tech companies, they're cutting jobs . We're continuing to see this in large tech companies and now it's spilling over to other corporations as well. And this is going to have a bit of a trickle down effect on the economy. So I know overall, unemployment is fairly low, but we're beginning to see these layoffs. And it will continue to work its way through the economy right now.

So this all means that not only are we going to see poor results for many companies in this upcoming earnings period for the fourth quarter, but it's likely for the first quarter and the second quarter when we go through results. We're going to see some pretty important numbers. And I think, the markets are going to discount that in over the next couple of months.

KK: I certainly agree with you on the employment situation. It's the kind of thing -- the data is bearing you out there with jobless claims creeping up and anecdotally, due to kind of like the big rounds of layoffs we're seeing, Meta is getting ready for another round of layoffs we've seen, and Disney ( DIS ) is getting ready to cut about 7,000 jobs and part of that ESPN is starting their job cuts next week reportedly. So I think that the labor market is softening and that's obviously going to be tough for the economic growth although it's good news in the Fed's eyes.

And speaking of the Fed, you did mention like tightened financial conditions in your article , and they definitely are tighter as we've seen the kind of unprecedented hiking cycle. But are they tight enough right now? They see they’re– I was looking, they're about as loose as they were right before Silicon Valley Bank. So is that -- that's loosened since that, kind of worry about the systemic event. So does that leave rate hikes on the table for the Fed? I know that one is definitely priced in so far, for the main meeting. And does that mean June is in play as well?

SC: In my eyes, I think we're going see a transition from rate increases, I think the Fed will pause. I'm not going to say that they're going to do it at the upcoming meeting. So whether it's the upcoming meeting or the following meeting, I think, they will start to pause. The caveat here is that there's more than one way to tighten monetary policy. And I'm not sure if you heard this the other day, but Janet Yellen was saying the banks are lending. And I think that's another tool that the Fed has. And as they increase lending, tighter lending, that's another way that it's going to make it difficult for the economy to grow. It's just going to be harder for institutions to get loans and for individuals to get loans. So there are not only rate hikes that the Fed has, they also have other tools. And I think we're going to begin to see some of those other tools come into play, as they sort of pause on the interest rate hikes.

So that tightening cycle could come to an end. But I think there's other types of tightening that can be out there.

KK: So on the equity side, then, let's say that, once the Fed hits its terminal rate, and – but it's still got tightening in its pocket. Will we see kind of another pop though? I mean, because we've got this kind of Fed put that's been helping us along for a while. Does it continue?

SC: Do I think that this Fed will continue to take rates up?

KK: No, just I was wondering, do the stocks continue to rally? And does the Fed put mentality continue?

SC: Yeah, all right. So I think, yeah, the market is going to have a period of nervousness. So I want to add a caveat, my long-term view is 12 months from now. We will probably see the market around the same place, or even a little bit higher. I think in the interim, it's going to feel -- 12 months is going to feel like five years. And we're going to see a lot of volatility. And I'm sure you've heard the old saying, the old Wall Street adage sell in May and go away .

I think we're going to experience that with stocks on the back of this earnings period. And as the market really tries to forecast what to do off the back of this earnings period, but also on the back of how they want to factor in the tightening cycle starting to pause. But at the same time, the tightening cycle increasing with bank lending. So the market’s got to try to figure that out. And I think in that interim, we're going to see some poor earnings.

So the market probably is going to see a corrective phase as we go into May and June, and maybe through the summer months, and it could be pretty ugly at some parts. And I think that's why it's really important at this point, if you're going to continue to be trading, you could take a step back and say, I'm closing my portfolio. I'm not going to look at it for another year.

Or you could say, like you’re in this environment. I want the ability to make money and to preserve capital. So in the interim, I'm going to focus on stocks that provide income and yield, or I'm going to focus on companies that I know are profitable, or I think there's a high probability that their EPS and sales numbers can beat. And we have the tools and resources for people to do that.

So if you are going to continue to trade and you want to make some money during this period, you certainly have the ability there to pick and choose what you want to do. So the market is up 8% already this year. Again, a lot of that I thought was sort of a reversion to the mean, being led by the mega tech stocks, having a major, major rally in the first quarter, and that was on the back of getting decimated over 2022.

And I think as results come out, there could be a headache here, people are going to say, oh, results are not so bad. These banks are doing really well. We have to wait for the rest of the companies to report and we really have to pay attention not only to the earnings beat, but also to the sales beat, and the sales beat is definitely coming in worse than expected.

KK: Well, as we wrap up, I just wanted to say that Canaccord's Tony Dwyer would definitely agree with you on a few things that you've said, especially the recession coming. He's pointing to the yield curve inversions, leading economic indicators, and now employment trends. But he also says, get it ready to take advantage of any weakness if and when bad news becomes bad news for the market. And we definitely have the tools at Seeking Alpha to help investors do that.

So it just leaves me to thank Steve Cress for his appearance and time today. And remember, you can get all the Investing Experts Podcasts at seekingalpha.com . Thanks so much for listening. And Steve, thanks a lot for joining.

SC: No, my pleasure. It was really great joining you.

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