CIBR - What Earnings Season Is Telling Us About The Health Of The U.S. Economy

2023-05-04 15:47:00 ET

Summary

• Why U.S. bank earnings suggest a modest recession?
• Potential impact of regional bank failures on the broader markets.
• When it comes to market uncertainty, is reality actually better than perception?

The latest U.S. earnings season may be giving some investors something to cheer about, as many results have come in better than expected. David Sekera, Chief U.S. Market Strategist at Morningstar Research, discusses whether those results are sustainable as economic clouds darken.

Transcript

Greg Bonnell: There are no shortage of catalysts in the markets this week. We continue to get earnings releases from some of the biggest companies on Wall Street. We do have concerns about the health of the US regional banks. And of course, we also have central bank decisions to weigh. Joining us now with his view, David Sekera, Chief US Market Strategist at Morningstar Research. David, great to have you back on the show. We've got so much to talk about. Why don't we talk about earnings season? We are in the thick of it right now. What have we been seeing so far?

David Sekera: Well, really, my big comment to start off with would be, companies really provide a relatively conservative or even like guided down at the beginning of the year in anticipation of an economic slowdown. And of course, that didn't happen. So earnings overall are going to be pretty easy to meet or beat at this point.

So when I look at the beginning of earnings season, it started off with the big banks. They were generally in-line to better than expected, and their guidance also was better than expected. The real takeaway there for me is the increase in loan loss reserves. But they only increased those loan loss reserves to being at slightly higher than historical averages. So what that tells me is that the big banks, they're preparing for a modest or a mild recession, but they're really not looking for a spike in defaults or bankruptcies.

Now, taking a look, then, at the big tech, also, for the most part, better than expected. They did give some softer guidance, but that guidance was better than a lot of people had feared. And I think the takeaway from the big tech is the economy still continues to soften, but it's not softening at an accelerated rate. And then this week, I'm really starting to shift my attention to what I call the real economy stocks, the industrial companies. I talked to our industrials analyst yesterday, and I like his takeaway. He quoted me, reality is actually better than perception. And he broke these into two different cycles. So again, there's the long business cycle stocks, and what he's seeing, therefore, the type of companies that have long lead times, like aeronautics and automation, those are still holding up pretty well.

But what he did notice is that he is starting to see weakness in the short business cycle stocks, those that are the quick turnaround between manufacturing and sales. So I think that is indicative of the economy starting to stagnate or maybe even soften.

Greg Bonnell: If we do get this recession that we've been talking about for so long, and that is being commented on by executives as they hand in earnings, the path forward could be a bit tough, it's going to be a pretty well-telegraphed one. I mean, have the market sort of fully priced in this fact that we keep saying recession, recession, recession?

David Sekera: Well, from our point of view, we actually think US stocks as a group are generally undervalued. And again, we cover over 700 stocks that trade on the US exchanges. And we'll compare the intrinsic value as determined by our analytical team on those stocks compared to where they are in the marketplace. So while we do think that stocks are generally undervalued, I do think we have a relatively rough road ahead for the next couple of quarters.

So we do think the economy, in the second quarter, is going to be stagnant. Really, we're looking for a zero GDP print for the second quarter, a slight contraction, probably just under a 1% contraction in the third, and then a very slow recovery starting in the fourth quarter. So that, of course, will put pressure on earnings for the next couple of quarters. And I do think that you could see some negative market sentiment.

Right now, if you look at the S&P 500, we're still pretty close to the top of the trading range we've been in for pretty much since last fall. And I think that in order to break through that ceiling, it's not going to be until later this year. I think the markets are going to be looking for leading economic indicators to not only really turn around and bottom out but start moving back upwards again.

Greg Bonnell: Of course, the big story in the markets over the last several weeks, of course, has been the turmoil that we're seeing in US regional banks. A lot of discussion as to whether this is very specific, idiosyncratic to these banks or whether we have another issue on our hands. How should we be viewing the regional banks right now?

David Sekera: Well, our takeaway on the regional banks are they're stressed but not broken. And when I look at our coverage of the regional banks, First Republic ( FRCB ) was the only one that we actually really questioned its viability to exist as an ongoing entity. In fact, we had lowered our fair value on that stock down to $3 a share, I believe, back in March, and then moved it down to 0 after their earnings.

But from a fundamental point of view, net interest income margins, they are being compressed, but we are incorporating that into our valuation models. In fact, we do forecast earnings probably already peaked in the fourth quarter of last year. And we think they're going to decline sequentially over the course of the rest of this year and probably not bottom out until fourth quarter or maybe even beginning of next year before they begin a slow recovery.

But overall, for long-term investors, we do think these banks will continue to earn the cost of capital or more. And so, yes, there may be some other bank failures out there, but of the regional banks we cover, we're just not seeing it. And, in fact, I think the market, to some degree, is overreacting to these short-term pressures, and in many cases, have probably pushed a lot of these stocks down too far.

Now having said that, if we do still see this negative sentiment in the markets, equity prices of those regionals get pushed down further, that may actually require the Federal government or the Fed to step in with some sort of new program to try and help alleviate that pressure.

Greg Bonnell: Of course, when you talk about First Republic there, the shares are being delisted in terms of what you saw. Coming on that name, not really going concern anymore, except for the fact that, of course, its assets got snapped up by JPMorgan ( JPM ).

David Sekera: Exactly. So I believe, officially, it was put into receivership by the FDIC. JPMorgan then bought the assets and also took the deposits with them. So the depositors there, they'll be made whole at the end of the day.

Greg Bonnell: When it comes to the big macro concerns, okay, we've talked about earnings, we talked about regional banking stress. Of course, then, we still have the central banks. In this country, we're on a conditional pause. We have been for quite some time. People trying to figure out what is arguably the world's most influential central bank, the US Federal Reserve, is going to get up to. How do we see the path forward for them?

David Sekera: I think at this point, everyone's really expecting the Fed and the US to be one and done at this point. I think the Fed's going to pause after this hike. And really, it's going to be a matter of how long can they keep rates higher for longer until the economy softens enough and inflation comes down enough for them to start cutting rates. In our view, inflation still comes down over the course of this year. And again, we do expect the economy will soften, probably bottoming out in the third quarter. So we think the combination will give the Fed the ability to start cutting rates. We think the first rate cut is going to be December of this year.

Original Post

For further details see: