02.02.2023 We’re in the busiest week of earnings season, looking out toward a year of uncertainty. If 2022 was the year when higher interest rates had an impact on the markets, 2023 is shaping up to be the year in which these rates truly influence the economy, inflation, earnings and jobs. Overall, Q4/22 results are falling short of expectations, at least relative to history, with roughly 70 per cent of companies having reported so far beating their profit estimates. Typically, more than three-quarters beat on the bottom line. And so far only half have outpaced their revenue expectations, a figure that is usually well over 60 per cent. Closely examining recent earnings reports could offer some clues as to what to expect. What do these tea leaves reveal?
Results from Microsoft, one of the world’s largest business software companies, suggest a slowdown in business spending for both hardware and software. Microsoft’s revenue growth decelerated to a six-year low. Along with the quarterly earnings release last week, management acknowledged that cloud computing slowed last year and is expected to continue slowing into 2023, on the back of slower business investment.
Last quarter’s GDP report showed business investment in information processing equipment plunged more than 23 per cent on an annualized basis. Meanwhile, worldwide PC shipments fell 29 per cent year over year, suggesting that the replacement cycle has extended. The PC slump is expected to last into 2024, as anticipated layoffs will further dent desktop demand. Small business optimism, a harbinger of business spending, has fallen below the 2020 pandemic low and is approaching levels not seen since the financial crisis.
Chipmakers are also feeling the effect of weak PC demand. Advanced Micro Devices (AMD) reported a 98 per cent profit decline last quarter, as sales linked to PCs were cut in half. Management warned of a 10 per cent revenue decline in Q1/23, according to The Wall Street Journal. Like AMD, Intel is similarly positioned in the PC sector. Other chipmakers, leveraged to the auto sector, witnessed a boost in demand as auto production ramped up.
Energy producers are basking in highest prices since 2008, as last May crude breached $120/bbl. It also resulted in the largest year-over-year gain in oil since 1979. Not surprisingly, energy giant Exxon posted a $59 billion profit in 2022, the largest in the company’s history. Exxon CEO Darren Woods anticipates continued growth in the fossil fuel sector as growing global demand will lead to higher energy prices. We share the view that energy prices will remain elevated.
The household sector is healthy, despite inflation headwinds. McDonald’s, the nation’s fast-food giant, reported 12.6 per cent growth in same-store sales last year as it benefited from an increase in meals-to-go. Management was pleased that US and European customers held up better than expected, given the economic backdrop. The company said franchisees boosted prices 10 per cent on average last year, suggesting that volume growth was closer to three per cent over the previous year. Nonetheless, households continue to spend on dining, albeit low-priced dining.
UPS, a useful barometer of e-commerce activity, disappointed Wall Street by projecting lower sales this year, representing its first revenue decline since 2008. Package volume is declining as consumers shift toward in-person shopping and spending on services. Internet retail sales plunged 1.1 per cent in December, marking its worst monthly showing since last March. Management said the company’s outlook reflects expectations for a mild US recession in the first half of the year before a recovery in the second half. Global trade growth is expected to slow as well. Labor costs are weighing on UPS’s profit margin, and the company faces Teamsters contract negotiations midyear.
General Motors (GM) offered a brighter forecast, reflecting optimism on the back of continued demand for trucks and SUVs, which are among the company’s most profitable offerings. GM projects sales volume to expand 5-10 per cent this year. Notwithstanding an incipient electric vehicle (EV) price war brewing between Tesla and Ford, GM expects to produce 400,000 EVs over the next 18 months, according to Bloomberg.
Caterpillar Inc (CAT), the industrial, mining and construction machinery manufacturer, offers a unique perspective on global economic trends. The company disappointed analysts earlier this week when it posted lower-than-expected quarterly profit for the first time since the start of the pandemic, which sent its shares to their biggest drop in four months. The company conceded that sales to China will be slower than expected this year as the world’s second-largest economy recovers from widespread lockdowns and significant overbuilding in the property sector. CAT warned that demand for the 10-ton-and-above excavator market, a benchmark for China demand, will be lower in 2023 than it was last year. New residential construction in China is 40 per cent lower than it was this time last year. Management is optimistic, however, that overall sales this year will be better than last year, largely due to the benefit of higher selling prices.
Bottom Line: We share the concerns expressed by these managers. The ravages of inflation are eating into household spending and consumers in the developed world are scaling back discretionary spending on goods, particularly via e-commerce, and shifting their buying preferences toward services. Thanks to a solid job market, household fundamentals remain strong. We will continue to track credit card balances; any further escalation could be a warning signal for household liquidity. We are already witnessing a pullback in business spending, particularly advertising – a troubling trend for the tech sector. We expect China will provide a near-term boost to global demand, but its property sector imbalances will likely lead to a slower growth trajectory there. We are penciling in a mild recession in 2023.