Trading Desk: Bulls Can Trust The Analysts . . . For Now

We’ve talked a lot about earnings this season for one simple reason: after all the COVID twists and turns, year-over-year comparisons finally matter again. And on that front, the market as a whole is showing just enough progress to keep the bulls cheering the resilience of American enterprise.

Let that sink in for just a moment. All the statistical noise of the pandemic is receding now. The lockdowns of 2020 that made comparisons to 2019 meaningless have rolled off the rear view. So has the Fed-fueled froth of 2021 that made everything look superficially fantastic.

The numbers we’re seeing compare well to last summer, right around the time new COVID fatalities finally started to bottom out in the U.S. as mass vaccinations took hold. Over the past year, Corporate America has made significant progress.

While the Ukraine war was a shock to oil markets, we haven’t seen anything domestically in the past year to rival the disruption the 2020 medical crisis left in its wake. And we definitely haven’t gotten a lot of help from the Fed to grease the corporate wheels.

If anything, the Fed has been a strong negative this year. When financing costs money, corporate operating costs naturally go up. And with inflation continuing to blaze, just about every corporate cost center is burning along with it. Margins contract.

But on the top line at least, smart executives naturally pass those costs on to their customers, continuing the vicious cycle. Revenue around the market surges in paper dollar terms, but in real terms a lot of companies are barely holding onto what they had.

Juggle all these factors and we’re left with a lot of persistent drag, a sense of rising weariness or falling spirit, depending on your point of view. It’s good not to have suffered any shocks like 2020 but the Fed is doing us no favors.

And so it’s remarkable that the market has squeezed even a little positive growth out of this environment at all. This is how our executives perform under pressure. They’re doing just well enough to push the bottom line forward . . . and they’re hitting their targets.

The Consensus Is Getting More Accurate

What I really want to talk about today is those targets. They’re getting more accurate. Fewer companies are surprising us . . . and when they do, it’s by a lower amount.

Some people might argue that’s because they’re struggling to meet their numbers. But no CFO or CEO wants to disappoint. They’ll do what they can to hit the target that every one of them can see.

“Consensus” is all around us now. I remember when earnings targets were distributed on a special dedicated machine that needed its own phone line. Today, anyone can look up what Wall Street collectively expects to see from any company.

The CEO may say the stock price doesn’t matter. The CFO knows it does. That’s the person who controls the accounting. They’ve always managed to hit the target if at all possible.

And the targets have been set a little low to make that possible. People love a success story. Nobody is happy when the market mood sours.

However, the bar is already low because we all know inflation is a drag. Margins are historically high at 12.3% of revenue . . . but a year ago, they were almost a full point richer, which means companies are actually eating that point of inflation instead of passing it on.

When the bar is set low, it only takes a little hop to hurdle it. When you’re Apple (AAPL) or Microsoft (MSFT), you know exactly what it takes to make that happen. Shareholders cheer.

But you aren’t going to try any harder than that little hop. You’re going to save your accounting wizardry for a quarter that really needs it.

It’s interesting that both AAPL and MSFT see growth reaccelerating from their recent results. Their wizards are on call to deliver a blowout quarter three months from now.

With so many smart people covering these companies, the target will rise. But it’s guidance that calls the shots . . . the analysts simply work with what they hear on the conference call.

Other companies aren’t quite so widely covered and don’t telegraph their moves in advance. Meta (META) kept the bad news to itself until it was too late to do anything but confess.

That was a real shock. And in a world where consensus is the only arbiter of success a lot of investors look at, the shock hurts.

Hitting the target is now the best test of corporate excellence. Of course, the numbers aren’t imaginary. You need to be running a real-world operation that brings in enough money to make it all happen.

But most of the time, you’re working off the same models as the analysts. Your ability to predict future cash flow uses the same systems as theirs. When something changes, you alert the world.

And then everyone updates the models to something that converges with reality on the ground. Our models, their models, internal models . . . the details differ but the broad strokes are the same.

What It Means For Us

For now, all we need to know is that the market as a whole isn’t caving in. There’s no shocking change that forced CEOs to lower their guidance en masse. We all know the downside drag factors. They haven’t changed.

And an area of the market that a lot of banks took their eye off is flourishing. Energy is a small piece of the global pie now compared to AAPL and MSFT. Every energy stock in America is smaller than either of these companies.

Think about that. All the oil. All the gas. Solar. Everything. Add them all up and they’re only a little bigger than Amazon (AMZN).

That’s the market opportunity. This 5% of the market is contributing all the upside surprise this quarter. It’s the brightest ray of unexpected light we’re seeing.

That’s where we want to be, right? My team is looking harder at ways to play the sector. I’ll be in touch.