Trading Desk: Take A Longer View For Earnings Season Clarity

While last week’s numbers gave us all the year-over-year clarity we needed, I have to say year-over-year comparisons have gotten so blown out that they’re practically meaningless. We need a slightly longer view.

Of course, this week will give us plenty more data points. I’m looking at PayPal (PYPL) and Advanced Micro Devices (AMD) tomorrow, as well as old economy names like Starbucks (SBUX) and Yum (YUM).

But the old economy seems trapped in the inflationary cycle, which means that end of the market is likely to lag. Big Tech, on the other hand, is in a better position to defy a slowing economy and keep growth alive.

We’ll just have to see. For now, I want to cut through the noise to find the deeper signal Wall Street needs to turn this relief rally into something bigger . . . or walk away for another 3-6 months.

Remember, a year ago the world was still feeling the rush of the Fed’s free money and even a tentative recovery looked stratospheric compared to 2020, when a lot of the numbers crashed.

When COVID locked down the economy, earnings across the S&P 500 dropped 11% on a year-over-year basis. Then, in 2021, they rebounded 47% from that dismal base.

And now we have our first shot at a relatively “normal” year since 2019 . . . or even earlier, if you consider the tax cuts as an artificial boost that needs to be discounted. After so many gyrations, a lot of people have lost their gut sense of whether the numbers are good or bad.

Is 4% earnings growth this quarter good enough to defy the Fed and the bears? How about 5% or 6%? What does it take to feel bullish about holding stocks for the next few months?

Year-over-year comparisons might still carry a lot of post-pandemic noise, but that’s all right. Enough years have passed that the peaks and valleys average out a little and once again let us see where the market sweet spots actually are . . . across the cycle.

Sector Strength Versus Crowded Stocks

In six months, we’ll be three years out from the initial COVID lockdowns. For now, halfway through the year, Wall Street has had a lot of time to weigh expectations against the shifting economic landscape . . . and with two quarters on the books (more or less), there isn’t a lot of room left for the landscape to shift dramatically.

We know roughly what we’re looking at for 2022. And so we can project back, year by year, to evaluate how much progress companies have made across the COVID bust, the hyper-stimulated free money boom and this year, when the Fed takes it away.

The first thing we see is that the three-year journey has been fantastic for business. Every sector is raking in higher revenue than it did in 2019. Nothing at this level has been left out or so crippled by the pandemic that the top line has declined since then.

Take that in. As far as Corporate America is concerned, it’s been a great three-year period . . . even if some of those years have been sluggish or even scary.

Of course, net growth is relative. Tech, communications, healthcare and materials producers have done better than the market as a whole, boosting their top line by 33-35%.

So has the consumer discretionary sector . . . but be careful here. We don’t mean restaurants and retailers. Most of the gain here has come for Amazon (AMZN), Tesla (TSLA), Home Depot (HD) and a select few other “new economy” heavyweights.

And then there’s energy. While 2020 was a crash, revenue across the sector is now tracking 56% above where it was in 2019. That’s the best growth around.

Below that, real estate has done okay, with 27% three-year sales growth projected for 2019-22. That’s about what the S&P 500 as a whole has been able to deliver. It’s pretty good. More to the point, while some landlords are hurting, others are doing just fine.

What About The Bottom Line?

Inflation and supply shocks have been a nightmare for some of these companies. Just look at AMZN, which has found it impossible to make money in the current environment. Sales have doubled since 2019 . . . but all that extra scale is worse than useless if you can’t spend less than you take in.

And there are other fallen giants. Meta (META) can’t maintain growth. The banks are collectively taking a big step back. By the end of this year, they’ll have barely 4% annualized earnings growth to brag about across the COVID era.

That’s less progress than the normally sluggish utilities. On average, just to keep up with the market as a whole, you need to show close to triple that level of growth in the long term.

That’s not quite what the market is on track to deliver this year, so Wall Street isn’t blind to signs of another recession on the way. Expectations are modest.

But that’s largely a factor of AMZN, META and the banks. Factor them out, concentrate on the other 65-70% of the market and it still feels a lot like a boom.

Now I know you’re thinking that Wall Street also anticipates this kind of economic crossroads . . . that 65-70% of the market must be overbought while the companies that are truly facing a recession are cheap, right?

Not so much. From an earnings growth perspective, the winners have been the materials producers, which have now practically doubled their 2019 profit, and energy, which has swung from deep losses back to big money. Those sectors are only up about 25% since the end of 2019.

The S&P 500 is up 28% over the same period. Weigh the growth numbers and tech has gotten a little ahead of itself but it’s not flashing any deeper bubble signs than the industrials or the utilities. Communications stocks (not counting META) actually look cheap.

So do healthcare and real estate stocks. In the long haul, they defy the boom-and-bust cycle and present attractive value relative to their post-COVID growth rates.

The long-suffering banks are almost there. But not quite yet. If you’re hunting deep value, buy the cable companies and telecom networks. Buy the materials producers for growth . . . and get an inflation hedge in the bargain.

And how about inflation? Since the end of 2019, prices are up a harrowing 14%, which means any investments you own need to hit that number just for you to avoid falling behind.

The banks haven’t done it. Communications stocks haven’t done it. Utilities and real estate have barely kept up.

But they have kept up. And that’s a lot better than bonds. However, that’s another story.