Clues from Earnings Season

The S&P 500 opened lower this morning but quickly turned around and is fighting for its 9th straight positive trading session. It’s pretty clear now that the year-end rally is upon us. Over that period the VIX fear gauge has fallen to 14.5 from 21. Gold and oil have traded lower. And bonds rallied as interest rates fell back. Bankrate.com says the average 30-year mortgage rate peaked out at 8.09% last month and is now back to 7.83%. This stabilization in rates is clearly having a positive impact on investor sentiment.

Economic data received over the past week confirm that US hiring activity is slowing, but so are labor costs. And labor productivity is rising at a rapid clip. Should they persist, these trends are good for corporate profit margins. On the other hand, financing costs are obviously much higher than they were a year or two ago. Investors are closely watching third quarter earnings announcements to discern whether corporate profits are improving or deteriorating.

With about 450 of the S&P 500 companies having reported third quarter results, it looks like aggregate sales & profit growth were anemic but positive. The worst performing sectors were energy (sales down 17% from the year-ago quarter) and materials (sales down 10%). While healthcare posted positive sales growth, profit growth fell 20%. So while we haven’t had to endure a broad economic recession, certain sectors or industries have clearly suffered through recessionary conditions. But the situation is improving. Last month Wall Street analysts expected aggregate profit growth to contract for the fourth straight quarter, but instead we saw positive growth. And it looks like this is the inflection point. Both sales and profit growth are now expected to incrementally improve over the next year.

Disney (DIS) reported mixed third quarter results yesterday. Total revenue grew 5% from the year-ago quarter, slightly below expectations. But earnings per share shot up 170%. The conclusion: management is serious about cutting costs. The announcement was a huge sigh of relief for investors and included some encouraging details. The video streaming business added 7 million new subscribers vs. 3-4 million expected. And while it posted a -$387mil loss, that’s far better than -$1.5bil loss in the year-ago quarter. Management believes streaming will become profitable by the fourth quarter of 2024. Next, ESPN actually beat analysts’ expectations for new subscribers and operating profit margin (here again, thanks to cost cutting). The theme parks business continued to shine, with 9% operating profit growth in the US. CEO Bob Iger predicted that free cashflow next year could approach pre-pandemic levels. Finally, some good news; the stock is up over 7% today.