An ( Earnings) Bridge Over Troubled Waters

1585 words – a 4 minute read.

Boy, I have to say it feels pretty good. To finally see some green on the screen, a green screen that stays for more than a day or two (best 3 day run since May & working on a 4th as I write). It feels like it has been ages since such has occurred. 

June was unrelenting and a very tough month for most long only investors. As such one is and should be, rightly skeptical of the sustainability of this most recent up move (SPY up 10%, Nasdaq up 13% from recent low). But something feels different as I noted to several buddies late Tuesday… things feel better, act better, charts look better, the news flow is not so one sidededly negative. One begins to wonder if the Crypto collapse (Terra, Luna, Celsius etc.) was the last shoe to drop & the ARKK, Apple, Netflix, Tesla jump the start of something new?

This week’s BofA Fund Manager Survey report helped provide that different feel. Titled “The Full Capitulation”, it went into great detail as to how bearish the investment community was, worse even than the GFC or 2001.  It noted that investors’ global growth & profit expectations were at ATLs, that investors had the highest cash levels since 9/11 & a risk exposure level below (below!!) that seen during Lehman’s implosion in 2008. 

Laid out with such clarity – it was one of their better efforts - with lots of chart support it struck me that if the community is so one sidedly on the side of the boat that says we are heading into another 2008 then I most definitely want to be on the other side.

There is no way we are going into anything remotely resembling 2008 – there is no comparison – banks just reported – they are stuffed with regulatory cash, are making billions, have a 12% ROE, enjoying their best loan growth in ages & a rising NIM for the 1st time in forever and selling at roughly BV (vs the 1.6x such a ROE would imply according to Ironsides Macro).

In 2008 the entire US banking sector was days away from going completely belly up – the entire US banking sector. I mean - come on.

Consumers are cashed up with debt service payments a fraction of what they were then. In a separate report, BofA notes that that consumer spending ran at a very strong rate of 13% Y/Y in 1st H 2022 compared to a 5% Y/Y rate in 1st H of 2019. Companies have trillions in cash on hand, yes, trillions, have pricing power for the first time in decades & have been battle tested over the past 2 years by the trifecta of Covid, Climate & Conflict. There is no HY repayment mountain, there is no HY energy segment going belly up in unison, there is no default cycle to speak of.

Ahhh, but there will be; that’s what the bears growl. Scratched up a little bit after having had their way for so long, the bears counter with the recession is coming argument, that earnings are going to plummet, stocks are going to get hit, the Fed will have to raise and keep raising, unemployment will grow and just you wait.

Well, as we discussed last week in “Title Fight  the early rounds have clearly gone to the Inflation Champ but this week’s round was won by the Earnings challenger. The set up has been visible for a while: US gasoline prices peaked back in mid June, rates peaked and stocks bottomed at the same time. Gas prices have gone down for what, 37 straight days?

Rates are off sharply, especially at the long end while inflation breakevens have likewise come in, suggesting Mr. Market believes the Fed will conquer inflation. The same is true over in Europe as the ECB mirrors the Fed by going strong out of the gate, raising rates 50 bp so back to zero and ending 8 years of negative rates while also adding a new tool, the Transmission Protection Instrument to its anti fragmentation arsenal.

And now earnings season is upon us and the first blush read is pretty good. LPL notes it’s very early in earnings season with “results from just 88 S&P 500 companies, but a 72% beat rate is solid, while corporate America is well on track to grow earnings north of 5% year over year. The consensus estimate for 2022 earnings has barely budged in July. Bottom line, the pessimism may be overdone”.

Investors have liked what they have seen with both the SPY and Nasdaq up above their respective 50dmav for the 1st time since April. The Nasdaq stretch (68 days) under its 50dmav was the longest since 08! Insider buy/sell ratio continues to power ahead – its track record is quite supportive of higher equity prices in the months ahead. The VIX is under its 200dmav for the first time since April and the UST MOVE index, which broke 150 not to long ago is sitting around 120. HY CDX has likewise come in strongly and broken under 500 for the first time since the release of the May CPI report.

We have espoused a positive earnings outlook for some time underpinned by our view that a high nominal growth world would be supportive of the top end and thus earnings given companies actually have some pricing power – something not in place since 08. With the US and EU growing at roughly 8% nominal, 4% earnings growth is not that high a bar. Keep front of mind that sales & profits are both reported in nominal dollars, a point of few folks are finally coming around too, including JPM & our friends Barry Knapp at Ironsides Macro and Jordi Visser of G Weiss being two.

US retail sales provide a good example. June nominal retail sales growth Y/Y was a solid 7.7%; in real terms it was – 1.2% Y/Y. The bear case for another 10-15% leg down due to a Fed induced, recession driven earnings collapse seems less and less likely. 

This is where the earnings become a bridge over those troubled, inflation roiled waters. Given the rate rollover, the selloff in commodities across the board, the easing of supply chain concerns (did you see the Philly Fed order backlog & delivery times data), the reopening of China, inflation’s peak should soon be upon us. Now this has been a very painful waiting period… believe me, I get it… but we are very close. Maybe July’s inflation print, maybe August’s but very close.

Earnings are the bridge till we get that clearly confirmed inflation peak. Once we get that, well then we get an environment that allows me to use one of my favorite reggae band’s (Steel Pulse) best lyrics: “when facts rock fiction, always cause friction”. As inflation peaks, stocks take off and we get the technical confirmation (breadth thrusts etc.) we need to say we have put in a durable bottom. Ned Davis Research notes that the HF community has one of the largest net short US equity positions in the past 15 years – perfect fuel for that friction.

Jordi’s most recent video  laid out several examples in the 1970s, 80s and 90s demonstrating how stocks took off once inflation peaked…. It didn’t matter how far down inflation fell ( the how hard will it be to get to 2 or 3% question) because stocks know then that the Fed will be measured in its approach, thus the risk of a Fed mistake becomes less and thus recession/earnings risk fades and risk assets can catch a bid.

We continue to note the strength of the Innovation space with ARKK finally breaking through the $45 level and sprinting to $49, up a cool 40% from its Spring low, helped by TSLA which beat Q2 EPS estimates by roughly 25% as the EV revolution rolls on. Climate related ETFs are also doing well (LIT up close to 20% from its April low) and while China ETFs have cooled off the outlook remains positive as KWEB for example remains a solid 25% off its April low. Growth over Value as Apple breaks back above $150.

Many technical minded folks are focused on the USD which has been termed the “wrecking ball”. While it has held up even as long rates have come in, a $ rollover here would get a lot of folks feeling good about equities & commodities. We are watching carefully. Europe is similar: its equity was up yesterday even with a 50 bp surprise hike from the ECB coupled with Draghi’s resignation in Italy – both perhaps offset by Russia’s decision to restart Nat gas flows. When Nat gas clearly peaks in Europe.. watch out above!

Time is passing and it just might be getting a little tight under the collar for the very large bear community. Of course next week is the 1st read on Q2 US GDP and if its negative as Q1 was then we might get the recession crowd doing the wave but its earnings that tell the tale and so far they are giving the challenger a little lift in the legs as we enter the late rounds.

Enjoy this Bloomberg Radio clip  from last night – focus on US earnings & the China outlook.

This fighter is going on vacation – no Musings next week, back on August 5th… 

Stay Frosty my friends!