Shouting over Earnings

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Our hope was to see earnings take the day and provide a more positive backdrop to market sentiment. According to FactSet, “for Q1 2022 (with 20% of S&P 500 companies reporting actual results), 79% of S&P 500 companies have reported a positive EPS surprise and 69% of S&P 500 companies have reported a positive revenue surprise.”

Although still early in earnings season, companies are beating earnings expectations by nearly 200 basis points (2%). 1

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Unfortunately, it appears that no matter how hard companies work to beat profit expectations— despite a ground war in Europe, inflationary pressures, and ongoing supply chain/ zero Covid issues in China—the Federal Reserve is focused on talking over earnings.

Here are just some of the Fed headlines from last week:

Chair Powell at last week’s meeting of the International Monetary Fund 2
“It is appropriate in my view to be moving a little more quickly” to raise interest rates, “I also think there is something to be said for front-end loading any accommodation one thinks is appropriate…I would say 50 basis points will be on the table for the May meeting.”

St. Louis Fed President Bullard at Council on Foreign Relations3
Federal Reserve Bank of St. Louis President said the “central bank needs to move quickly to raise interest rates to around 3.5% this year” with multiple half-point hikes and “should not rule out rate increases of 75 basis points.”

Cleveland Fed President Loretta Mester in a CNBC interview4
“I would support at this point, given where the economy is, a 50 basis-point rise in May, and a few more to get to that 2.5% level by the end of the year.

Former Fed President Bill Dudley Bloomberg Opinion (4/7/2022)5
“It’s hard to know how much the U.S. Federal Reserve will need to do to get inflation under control. But one thing is certain: To be effective, it’ll have to inflict more losses on stock and bond investors than it has so far.”

It would seem obvious to any observer the Fed is now on a path to create some demand destruction amongst consumers and investors.

Look no further than home mortgage rates. 6

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A 30-year conforming mortgage at 5.34% may not seem that bad historically but, the sudden rate of change from around 3% at the start of the year is breath taking. 7

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Fannie Mae, the world’s largest sponsor of home mortgages, is now calling for a mild recession later this year. The full report is linked here – it’s a quick read on how they see housing play out in the coming months and years. 8

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Just a few charts tell a compelling but, challenging story. With rising rates and home affordability at record highs, Fannie expects sales to turn down in the next six months and home price increases to revert to zero growth.

Apparently, investors aren’t the only ones that are fearing the Fed. It’s almost hard to believe the Fed has only raised interest rates once by 25 basis points (¼ of 1%).

This week, we will get a good look at global GDP readings. The U.S. will report Q1 GDP which is expected to come in at an anemic 1.3% according to the Nowcast by the Atlanta Fed. 9


The 1% growth expectation is also significantly influenced by the strength in housing during Q1. (I’ve highlighted the housing contributions in yellow below). 9

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Now, let’s contemplate what happens to U.S. GDP if we lose some support from housing starts, existing home sales, new home sales, and construction spending. Things turn negative in a hurry.

Fannie Mae may be more accurate than we want.

Before we panic, it’s also important to realize the Fed will likely not be able to raise rates as much as anticipated (something like 2.5 percentage points this year) if we slip into a mild recession. Further, investors will likely anticipate a more balanced interest rate picture and resume buying over selling. At least that’s what history suggests during past recessions. 10

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The Fed will certainly accomplish their goal of dampening demand. Let’s just see how skilled they are at surgically controlling a 24 trillion-dollar economy and consumer sentiment. Maybe, shouting over earnings is not the best strategy.

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Tim Phillips, CEO, Phillips & Company