Earnings Season Is Upon Us

Major stock market averages opened slightly higher this morning, but quickly lost momentum. Currently, the Dow is down 385 points, the S&P 500 is down .16% and the Nasdaq is flat. And yet, the VIX Index remains below 20, suggesting no panic among traders. And it’s true that so far this year, the stock market is in a general up-trend. Why? Inflation is clearly slowing and the economy isn’t falling off a cliff.

Investors have turned their attention to fourth quarter earnings season. Last week the big banks kicked it off with mixed reports which pushed stocks higher. Revenues rose and profit margins improved due to higher interest rates and a resilient economy. Bank of America (BAC) and JP Morgan (JPM) posted double-digit revenue growth. Federal Reserve rate hikes mean that bank loans are more profitable, but of course higher rates discourage lending and generally slow the economy. As evidence, Wells Fargo (WFC) said mortgage originations are down 70% from a year ago. And investment banking revenue tumbled 50-60% at BAC and JPM. Bank CEOs are jittery about the possibility of a recession, but so far, loan losses are modest. Collectively, the banks set aside a rather tame $2.8bil to cover potential loan losses if the economy falters this year.

Today, we got reports from two large wealth management firms that sent their stocks in opposite directions. Morgan Stanley (MS) is up 6% despite posting revenue down 12% from a year ago, as well as lower profit margins. Fortunately, analysts & investors were expecting a terrible quarter for investment banking. What they didn’t expect was that the trading and wealth management businesses help up rather well. On the other hand, Goldman Sachs (GS) disappointed investors with unexpectedly weak revenue and profits, and the stock is down 7%. One problem is that management has failed to aggressively control costs in the face of weaker business trends. Operating expenses rose 11% from a year ago.

US consumer sentiment improved considerably this month. The University of Michigan’s survey revealed lower inflation expectations over the next year (4%), and a bit more optimism about economic conditions. Bloomberg News attributes the improvement to the fact that incomes are still rising and inflation is clearly easing. And yet, two-thirds of respondents expect an economic downturn. Clearly, that downturn is expected to be much less wrenching than the Covid recession and much less drawn out than the Housing Crisis.

US capital markets got some help from overseas this morning. First, the European Central Bank (ECB) is beginning to consider slowing down the pace of future interest rate hikes. This seems to suggest policymakers believe they’re getting inflation under control and won’t need to be as aggressive with monetary tightening this year. Of course, the US Federal Reserve is talking about the same policy shift. But what makes this interesting is that Europe is far behind us in terms of the inflation spike and monetary policy response. Here’s what I mean: US inflation peaked at 9% last June and has since fallen to 6.5% in the wake of the most aggressive rate hike cycle in four decades. By contrast, European inflation surged to 10.6% in October and has only begun to decelerate in the last two months. The ECB has barely begun to raise interest rates.