Big Earnings and Bigger Questions: How This Week Could Shape Market Sentiment

<span id="hs_cos_wrapper_name" class="hs_cos_wrapper hs_cos_wrapper_meta_field hs_cos_wrapper_type_text" style="" data-hs-cos-general-type="meta_field" data-hs-cos-type="text" >Big Earnings and Bigger Questions: How This Week Could Shape Market Sentiment</span>

Stocks had a mixed close on Friday with tech shares a shining light amidst nerves exposed by rising interest rates and fear that the Fed will abandon its friendly ways. Consumer sentiment was revised upwards by University of Michigan on Friday – consumers will need high spirits to keep up with rising expectations of economic growth.

 

Wide awake. Did you ever wonder why certain over-the-counter decongestant medications are kept behind the counter? Well, I can tell you, based on my complete lack of sleep last night, exactly why 🥱. Let’s just say that I hit the ground running this morning, which is good because I planned to help you hit the ground running for the crazy week ahead – and, as implied in the last sentence, I had plenty of time to contemplate it. I would say that it is safe to assume that this is one of the most critical weeks of not just earnings season, but also the economic calendar.

 

Let’s start with earnings and the S&P500. So far, we received reports from around 2/3 of the Financials, which had an impressive average EPS beat of around 9.7%. Financials were the first sector out of the gate and its strong showing set the stage with a positive taste and the markets responded with single day price increases following announcements of around 1%. Industrials, Consumer Staples, and Consumer Discretionary stocks are around their half-way mark and they all beat on EPS with an average of 2.69%, 2.92%, and 10.31%, respectively. In the day following the announcement, they had a mixed response of -1.2%, 0.7%, and -0.3%, respectively. That’s right two of the three fell on average, with the only winning sector, Staples, gaining only a small amount.

 

Before we move forward, we have to talk about value stocks versus growth stocks. Very briefly. To be considered a value stock, a company must have a long history of not-large, but consistent earnings growth. These companies typically pay dividends for two reasons. 1) Because they can, based on their steady earnings, and 2) because they HAVE TO, otherwise no one would want to invest in them due to their slower growth. Consistency is name of game for value stocks. Now, to be considered an attractive value stock, a company should be trading around or below the average pick-your-favorite-multiple; let’s go with expected 2024 PE (price to earnings ratio), because that is the most common. There are lots of value stocks in the Industrial and Consumer Staples sectors. Industrials as a sector are trading around a 25x PE multiple, which is high compared to its longer-term range of 15x to 20x. Consumer Staples are trading around 22x expected ’24 PE, which is also slightly on the higher side of its typically volatile, historical range.

 

Industrials include companies like General Electric, Caterpillar, Lockheed Martin, Boeing, Fedex, and CSX. Consumer Staples includes companies like Walmart, Coca-Cola, Kraft Heinz, Archer-Daniels-Midland, and Clorox. Knowing what these companies do, can you see why most of these would be considered value stocks? As explained before, and based on this, can you see why an overvalued, value stock may be less attractive than a fairly valued, or cheaply valued, value stock? Not sure? I’ll give you two obvious reasons. 1) because the more you pay, the smaller the dividend yield, and if you are buying for the dividend, that is not a good thing, and 2) because if you are not expecting much earnings growth, the more you pay, the less total growth you will get.

 

So, I have just described to you how most folks view most stocks, right? Regardless of what type of stock, nobody wants to overpay for a stock. When you hear that a stock is “expensive,” meaning it has a high PE ratio relative to its peers or its own history, you will probably decide not to buy the stock. It’s common wisdom that doesn’t require a doctorate in finance 😉. Of course, we cannot just end with this; there has to be a catch. No peaking! Guess what I am going to talk about next? I will give you a hint. Tesla reported earnings last week, and it beat on by a lot.

 

Tesla happens to be in the Consumer Discretionary Sector with the auto manufacturers Ford and GM. That sub-industry is trading with a 2024 expected PE of 33x, which is pretty expensive compared to its pre-pandemic multiple of around 6x. Of course, that is because of Tesla with its now 2024 expected PE of 112x. That is not a typo! Last week on the day after it announced its beat, the stocks rose by almost 22%. Why on earth would an investor want to invest in such an expensive stock? And it doesn't even pay a dividend! Come on, you know the answer. It’s because many believe that the company has great growth prospects for the future, and they are willing to take the chance that the company’s stock will rise as those prospects are realized. Tesla is a great example of a Growth Stock, and it also happens to be the first Magnificent-7 stock to announce earnings. You see where this is going?

 

In the week ahead, we are going to get earnings announcements from five of the remaining six Mag-7 stocks. Do you want to guess if those stocks are value or growth stocks? Those five stocks are spread out over the Information Technology, Consumer Discretionary, and Communications Services sectors, though most investors consider them “tech” stocks. The Information Technology sector, in contrast to say Staples and Industrials is considered a growth sector. Stay with me. Here is where things get a little spicy. I am sure that you have heard that “tech stocks are expensive.” That kind of makes sense given that sector is trading with an expected 2024 PE of 34x. As you might guess, it has bounced around in the past 4 years, trading in a range higher than previously, but no matter how you look at it, 34x is high relative to its history. Unlike the rich PE multiples of 25x and 22x for Industrials and Staples, investors may still choose to pay the high multiple of 34x, because of the future growth prospects offered by stocks in that sector. I would take it a step further and offer this. An investor looking for growth must be willing to buy expensive stocks. Almost there, stay focused.

 

I am trying to give you a rational framework to understand the irrational behavior of not just tech, but the highly-watched Mag-7 that will come in this week. For example, the next Mag-7 stock out of the gate will be Alphabet, tomorrow. Its expected PE is around 20x. Wow, a growth company in the Media industry group within Communications Services. That industry’s expected 2024 PE is around 24x which makes Alphabet, cheap relative to its industry and its historical PEs around 30x. To be clear, that doesn’t mean it’s a hands down buy. Sure, it has great growth prospects that exceed the broader market. What you have to ask as you read through its earnings report is “is the stock cheap for the right reasons or the wrong ones?” If you read things that make you believe that future growth is going to be weak, well then, it may pay to wait for a better buying opportunity if you are looking to buy, but you may choose to hold if you already own it. If you hear that prospects are good, you may have a chance to get in while the stock is on sale. You will need to apply similar logic to Meta also in the same industry when it releases its earnings a day later along with Microsoft, which is in the Information Technology sector. Finally, on Thursday, we will hear from Amazon and Apple which are in Consumer Discretionary and Information Technology, respectively. This week’s Mag-7 announcers are expected to deliver EPS growths of 24%, 20%, 4%, 59%, and 8%, respectively. Those are all better than the overall expected S&P500 growth of around 3.5%.

 

What that all means is that everyone, EVERYONE will be watching those earnings announcements very carefully. The stakes are high, but commensurate with the higher risk is the higher potential return. If you don’t believe me, just look at last week’s Tesla announcement. I know that this is an awful lot to take in, and I didn’t even discuss the macro, economic releases that are expected this week. Those can spoil or enhance any of your well-thought-out plans. Those include GDP, PCE Deflator (the Fed’s favorite gauge of inflation), and the Unemployment Rate (the Fed’s favorite gauge of the labor market). At least the latter 2 will inform the Fed in its next interest rate move. Wait, did I tell you that interest rates also affect the valuations of companies, especially growth companies?

 

Better be on full alert this week. I suggest eating healthy and getting some good restful nights of sleep. Perhaps you should stick to some natural remedies if you are suffering from nasal congestion.

 

FRIDAY’S MARKETS

2024-10-28 _markets2

NEXT UP

  • Dallas Fed Manufacturing Activity (October)  may have slipped to -9.2 from -9.0.
  • Later this week we will get lots of earnings along with more housing numbers, JOLTS Job Openings, Consumer Confidence, GDP, Personal Spending, Personal Income, PCE Deflator, and the monthly employment numbers. Download the attached earnings and economic calendars for important details.

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