Good Evening:
Markets had a relatively strong week, given what we’ve been seeing, with a sour ending. This S&P 500 actually got above 4,000 today briefly but retreated into the close. Snap reported earnings after the bell Thursday and had a significant miss. Several downgrades followed. The company was down nearly 40% into the close. The action in Friday’s market suggested investors are worried Snap’s weakness foretells weakness for other companies who butter their bread with digital advertising. Communications Services was the biggest laggard, followed by Technology. Defensives saw relative strength.
This risk is more idiosyncratic to advertisers in particular and represents a nasty crosswind with economic activity slowing. Apple changed its privacy policy settings in its vast and lucrative mobile ecosystem to switch off its Identifier For Advertisers (IDFA) that is so essential to companies like Alphabet and Meta to inform their advertisement strategies and assess their success. Both companies were down over 6%.
The markets still managed to close the week positive. While Friday’s drop was big it was concentrated mostly in digital advertisers, a few of whom are huge parts of the index. Bank earnings showed a stronger US consumer than those with mounting growth fears likely would have predicted. At Bank of America, repayment on credit cards, auto loans and home equity products actually increased from a year ago. Signs of credit distress were down across the board. Banks have had to set more aside for loan losses, which can make the numbers a bit confusing. Nonetheless, underlying credit strength when looking at loan performance seems strong for the moment. Consumers are starting to use credit more heavily as their savings get exhausted, but that doesn’t necessarily suggest imminent recession. American Express, for instance, showed a 31% increase in revenue.
On the strong side of the earnings season Netflix delivered results that were decidedly less bad than anticipated and this helped their shares rally. Tesla also had a great quarter. Despite the companies that have beat, earnings for the season are on track so far to have the lowest annual rate of growth since Q42020. Next week will have crucial earnings reports of many large technology firms. They have been rallying lately and given their weight in the indexes, this will be a very important catalyst for how the market behaves. Some large technology firms have announced hiring freezes which has prompted some apprehension.
The events in Europe have been catching the attention of the world this week. The collapse of the Italian government led by former ECB Chairman Mario Draghi gave investors apprehension and maybe a little bit of the wrong kind of nostalgia. The other issue in Europe has been whether or not the Russians would permit the renewed flow of natural gas through the economically crucial Nord Stream pipeline. The Euro has been retreating against the dollar but has hovered just above parity. Fears of a renewed sovereign debt crisis in Europe are rising. The German economy has become more and more dependent on cheap Russian energy and if a complete closedown of the pipeline occurred the effects on German GDP could be devastating.
The German economy is the bulwark of the Euro. Weak German growth combined with rising rates and hawkish ECB could make the sovereign debts of the heavily indebted southern countries re-emerge in problematic ways. While Putin has let the partial flow of gas resume, keep an eye out for him to continue using this leverage to apply pressure to the West and shake European unity. The closer we get to winter, the more effective this leverage likely becomes. This issue could become larger as time goes on and Putin twists the cranks to a trickle or to nothing. One potential problem that could be exacerbated by issues with the Euro is persistent dollar strength.
Morgan Stanley Analyst Michelle Weaver has estimated that for every percentage point rise in the US dollar, S&P 500 earnings would get hit by 0.5%. So, by her math, since the dollar has risen 16%, this would equate to an 8% hit to earnings. Larger cap companies usually have a greater percentage of international sales. IBM was once company that saw dollar strength hit its earnings. Microsoft also guided a few weeks ago to this effect. Given that markets are having the weakest earnings season in a while, the downside action hasn’t been as bad as some expected. Strength in economic data like labor markets and credit performance as well a rally in high-yield debt this week could be helping give investors suffering from dismal sentiment levels something positive to dip their toes into.
This earnings season is very important for the direction of markets. As we receive more data it may become clear that fears of recession are overblow. If this insight converges with softening inflation, a strong rally in the second half is possible, as Tom Lee will discuss below.
