The latest U.S. earnings season is almost done, and the results suggest the economy may not be slowing as much as initially feared. Damian Fernandes, Portfolio Manager at TD Asset Management, speaks with Greg Bonnell about earnings and the implications for markets.
* Thanks, Greg. Great to be on.
* So we've been talking of a recession, fear of recession on the horizon for a long time now. And, yet, we're in the thick of another earnings season. In terms of corporations, what are they telling us about what they're going through and what might be ahead?
* Well, they're telling you things are slowing. But, interestingly, things are slowing less than people are forecasting. When you look at just the breadth of earnings season-- and, by the way, we're basically done earnings season. The only companies left are the retailers who have a month lag. So about 440 companies in the S&P have reported. It's about 90% of market cap. And while earnings are negative, they're less negative than people were expecting.
* And I can put some numbers into that, right? People are expecting close to high single digit, like -9% earnings growth. It's coming in at -3%, -4%. So materially, much better.
* And the top line is still growing because inflation is still growing. So that helps support the top line. So on balance, what you're finding is that this earnings season is actually surprising in how less bad it is, which I think it gives you a sign or just your opening comments or when is this recession coming? Like when is this--
* Even though we've been signposted quite a while now.
* I think people just have to think about a conventional recession. And muscle memory forces people to think about the most traumatic experiences. The most traumatic recessions we just had-- the COVID recession or the '08 recession-- don't think of that. This is a much more conventional recession. Think '91, think 2001 where some parts of the economy will slow and some parts of the economy will just tether along and provide some impetus for growth.
* In terms of what companies are telling us about what they expect going forward, I recall among some of the big tech names, they said, well, we're seeing slowing the amount of customers from some of our cloud services, other areas as well. It seems like they're preparing for it. But are they overly dire or is this sort of what we'd expect, run of the mill?
* Well, just we can take about-- so year to date, what's been leading the market? I'm sure in other shows, you've talked about this, right, the FAANG stocks, right, like FAANG bites back. But, interestingly, those stocks, those secular growers are actually showing the best earnings delivery, right?
* We had Microsoft on the day reported earnings was up 7%. But Microsoft is calling for up to 9% constant currency revenue growth, double digit EPS growth. Facebook was a surprise-- Meta. Sorry, Facebook, I still remember the old ticker.
* I still call it Facebook.
* I know. I know.
* I don't remember Meta at all.
* If we talk about muscle memory, that's-- it's etched into my head. But Meta reported it's calling for revenues to be up high single digits next quarter. That's much better than people feared with a pullback in advertising. So I think that broadly, parts of the market are growing nicely or are delivering earnings that a little better than expectations. And there are some parts that are lagging.
* What are the markets really waiting for I guess in terms of a direction? We've had the recession for years for the longest time. We've got a US Federal Reserve that might be on pause. I mean, they're not using that word, but the Street seems to be thinking, well, maybe they're done or maybe there's one more. I mean, what is the catalyst going forward?
* The catalyst, I think what's surprising people is, why isn't the market lower, right? That's front and center. We're talking about earnings. We've been talking about it for a while. Actual company earnings are negative year on year. They're better, but they're still negative.
* And I think what people, or at least my view is, is that the reason the market is where it is and hasn't fallen out of bed is because think about last year and what caused your viewers' indigestion and what caused you to reach for the Pepto-Bismol? It was four things really, right? It was accelerating inflation. It was federal reserves that were tightening rates aggressively to address that inflation genie out of the bottle. We actually had-- we still do, but there was a war that lit a fuse under commodity prices, that exacerbated those inflation worries.
* And then, finally, the world's second largest economy was still in a zero-COVID policy in China. As we look forward today, and the start of this year too, a lot of those-- 3 and 1/2 of those four things, sadly, tragically, there's still a geopolitical conflict. But every commodity price from WTI to potash to iron ore is lower year on year.
* The second largest economy is now accelerating, as it wakes up from its COVID hangover. And inflation is falling. It's falling. Maybe it doesn't get to the Fed's target of 2%, but it is falling. And so that kind of puts the Fed out of the game, right, your initial comment. So I think these big-- there's things to worry about. This isn't all like blue skies ahead. We do have some worries. But the main agitators of last year's market performance actually look to be receding.
* Markets, we are told, are forward-looking instruments. So are they looking past perhaps a mild recession, a soft landing, whatever people are thinking it's going to be and looking to the other side of it?
* Yeah, I think that is the pivotal question. Right now, as I was talking about, it's still not sunny skies, blue skies ahead. It's because we're not sure about the magnitude of this drawdown. What I mean by this drawdown, I mean this economic pullback.
* Look, we might be going to recession. We might be going to soft landing. I think the market is pricing in a scenario where we're going into a softish landing, a shallow recession where we can recoup last year's earnings by sometime next year. If what's happening with credit tightening in the US or if something comes out of left field, if we have a much more traumatic pullback, then the market, that's when the market would get it off its skis, it would cause concern. Well, we're following these things, something else that I'm looking at is that that's giving me a source of grief is probably debt ceiling negotiations that are down the pipeline.
* All of these things can take a regular slowdown or a run of the mill pullback, shallow recession. And it could metastasize into something much more deeper. And then that's when the market falls out of bed again.
* We've been Fed watchers, obviously, central bank watchers for the past year for a very good reason, as you said, this very aggressive rate hiking campaign. It seems that there's parts of the market and probably think of more fixed income, the bond market, that thinks that they're going to be turning pretty quickly from being very aggressive in terms of tightening policy to suddenly slashing rates. How does that actually line up with reality, do you think?
* Look, I try and think about historical precedents. And historical precedents being and not being a fixed income expert, but just having been able to weigh on this is that the Fed normally tightens till something breaks.
* Well, guess what? They broke three regional banks and a global investment bank in this tightening campaign. Historically, when you think of what's happened is that after something after you've had a tightening campaign has led to a financial crisis of sorts, the Fed is on pause. And I think that playbook probably applies.
* In terms of Fed cuts this year, we'll just have to see if the data plays out. If the economic data continues to show up like the earnings data, which is not as bad as feared, maybe some of those cuts have to be walked back. Or maybe not, if the economic situation continues to slow. But, in general, I think the initial part of your comment, the fact that the Fed being on pause or on hold with potential for cuts, I think that's very likely.