Inflation And Banks Drag Stocks Lower Despite Earnings

The earnings season began slowly last week, with only 10 S&P 500 companies reporting. Banks were a large contingent of the reporters, which boosted the sector’s earnings expectations for the quarter as all the banks reported better-than-expected earnings. The first-quarter earnings season gathers momentum this week, with 41 S&P 500 companies scheduled to report. A more detailed preview of the earnings season is available here.

Bank and financial earnings are again a heavy dose of the second week of the earnings season. Among the financial companies scheduled include Charles Schwab (SCHW), Goldman Sachs
GS
(GS), PNC Financial (PNC), Bank of America
BAC
(BAC), Discover Financial (DFS), and American Express
AXP
(AXP). Other notable companies releasing earnings include Johnson & Johnson
JNJ
(JNJ), Netflix
NFLX
(NFLX), and Procter & Gamble
PG
(PG).

The S&P 500 slumped by 1.5% for the week. The 10-year Treasury yield rose from 4.4% to 4.5%, causing a 1% decline in the Bloomberg Aggregate Bond index. The Magnificent 7, consisting of Microsoft
MSFT
(MSFT), Meta Platforms
FB
(META), Amazon.com (AMZN), Apple
AAPL
(AAPL), NVIDIA
NVDA

DIA
(NVDA), Alphabet (GOOGL), and Tesla
TSLA
(TSLA), bucked the trend with a gain of 1%.

Despite the rise in the 10-year Treasury yield and the 2-year moving from 4.8% to 4.9%, the more economically sensitive cyclical stocks outperformed the less-sensitive staples. Stocks remain seemingly unconcerned about the risk of recession despite the rising yields.

At this early point in the reporting season, blended earnings, which combine actual with estimates of companies yet to report, are worse than forecasts at the end of the quarter. All the banks reported better-than-expected results last week, boosting the expected earnings growth. Net interest income guidance, which is the earnings from lending, was generally not as good as hoped, sending the bank stocks lower. Progressive
PGR
(PGR), the insurance company, also posted strong earnings relative to estimates, boosting the sector’s estimates.

The healthcare sector was the biggest detractor from S&P 500 earnings growth last week. Earnings estimates for Bristol-Myers Squibb (BMY) were slashed, sending the healthcare sector estimates to -25.4% year-over-year. The decline in Bristol’s earnings estimates was related to the accounting treatment of in-process research and development from its acquisition of Karuna Therapeutics. According to FactSet, if Bristol-Myers Squibb were excluded, the growth rate would be expected to be -6.8% for the healthcare sector.

Sales growth is closely tied to nominal GDP growth, combining after-inflation economic growth (real GDP) with inflation. With nominal GDP growth likely solid year-over-year for the first quarter, topline revenue growth for companies should have a tailwind. So far, with a few companies reporting, sales growth has moved fractionally lower than expectations going into the earnings season.

So far, the blended earnings performance has underperformed expectations at the end of the quarter. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter is at -0.9% year-over-year, below the expectation of +3.5% at the end of the quarter.

Despite the official kick-off of earnings season, the biggest story of last week was another higher-than-expected reading for consumer inflation (CPI). March CPI was 3.5% year-over-year versus estimates of 3.4% and February at 3.2%.

Perhaps more concerning than the headline inflation reading was the sharper rise in the supercore CPI reading, which measures services inflation and removes the distortion from the government measure of housing inflation. If this keeps up, it may throw a wrench into Federal Reserve chair Powell’s narrative that wage growth doesn’t drive inflation. As a positive, the Atlanta Fed’s wage tracker has maintained a downward trend, so this may be a bumpy last mile of fighting inflation rather than a complete setback.

The outstanding questions about inflation combined with resilient economic growth lifted Treasury yields and sent the odds of a June Fed rate cut crashing down to 30%. The probability of a July start to rate cuts now stands at 66%….