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Several U.S. bellwethers have reported their quarterly results. While some have missed, others have surprised to the upside. Greg Bonnell speaks with Damian Fernandes, Portfolio Manager at TD Asset Management, about the key themes emerging and what it may mean for investors.
Greg Bonnell: We are nearing the halfway point of earnings season in the United States. Some of the biggest companies have delivered their latest quarterly results. What are the big takeaways so far? Joining us for more, Damian Fernandez, portfolio manager at TD Asset Management. Damian, great to have you here. This has been a pretty interesting earnings season. What’s top of mind for you right now?
Damian Fernandes: Always– it’s great to– thanks for having me here, Greg. And top of mind, and you said it in the opening comments, the market’s kind of flat. But, Facebook, a large-cap tech company, is off 20. Google was off 10 yesterday. So it’s interesting that you have these really large mega-cap companies that are off significant degrees, and justifiably so given earnings, but the rest of the market is flat. It’s because there’s a lot of good things happening. In this reporting season, look, we can talk about earnings broadly, but there’s been a few surprises, right. Caterpillar is up 7%, 8% this morning on better than expected sales and orders. We had McDonald’s up. And so, I think broadly, people are so focused on what’s been working for the last few years — technology, Google, Facebook, and so on. But under the surface, you’re actually having this move away where earnings delivery is now coming from sector outside of tech. In fact, I was just looking at yesterday who reported between Google and Facebook, their earnings are off high single digits year on year. Revenues are just low single digits up. So there’s actually declines, fundamental declines, whereas the rest of the market is benefiting from this inflationary backdrop. So that’s how I’m thinking about it. I can put some numbers to earnings. But I’m happy to take it in the direction you want.
Greg Bonnell: It does sound like it’s sort of a stock picker’s market, right? Before we’ve had so many macro concerns guiding the trade throughout the year, and you get into an earnings season, and it is shocking to think a name like Meta, the kind of influence it wields, even over investor’s psyche could be down this much today and still the broader market is not feeling all that pain.
Damian Fernandes: Yeah, and I think, specific to Meta, and just broadly these very successful technology companies, they’ve had a wonderful period of these last few years where because of the pandemic and so on, you’ve had increased usage on their platforms. And they’ve never actually had to adjust to a slower economic environment. So what they’re facing right now– Meta and Google and in advertising. But Meta yesterday, said it’s going to keep increasing capital expenditure. It’s going to keep growing. Google is talking about increasing headcount. This is not conventionally what you do if you have your top line slowing and you have negative earnings. But they’ve never had to face it, whereas a lot of the rest of the market, having gone through the last decade of a slower, much more challenging economic backdrop, has had to adjust. So do I think at this point, we should be rushing in and Meta down 20% is a buy? No because we have no clarity on the outlook. We have no clarity on how much deeper advertising spend can go. Or before Meta decides to take an about turn in its capital expenditure.
Greg Bonnell: When it comes to those broader macro themes, I imagine they’re going to come to the fore again, probably as early as next week when the Fed has this meeting and comes out with this next decision. There’s a bit of a push and pull in the market now, and I’m trying to decide, do I want to focus on the fundamentals of the companies I own, or do I want to focus ultimately on trying not to fight the Fed?
Damian Fernandes: So a few things. The Federal Reserve is likely going to raise 75 basis points next week. But we are closer to the finish line of rate increases. When you think about the market pullback this year, globally, we’ve had– it’s because central bankers globally, we’re behind the curve in addressing and tackling inflation. They have ramped up quite significantly. In fact, we’ve had one of the highest– I’m not talking about the absolute level of rates, the change in rates. It’s been one of the fastest change in rates in the last two or three decades, depending on the country. In the US, you go from 25 basis points and they’re expected to peak at 4.75 next year. That’s a phenomenal level of increased tightening of financial conditions in a very short period of time. But we’re closer to the end than we are. And that obviously is going to lead to slowing growth, likely a recession. But that shouldn’t surprise people at this point. The pain we’ve seen in markets has been a realization that we are going to see earnings slow, economic growth is going to slow. So we can try and time markets and the Fed. We’d much rather advocate balance, having a diversified portfolio where you have cash flow-compounding companies. And right now, given the pullbacks to date, you’re seeing a lot of value in that.
Greg Bonnell: When we talk about the fact that the Fed’s end game is to slow the economy, as the BOC’s end game is to slow the economy. And that went from, can we avoid a recession? OK, how bad is the recession going to be? When we take it back to earnings and forecasts, are we actually seeing companies prepare investors, even admit to themselves that a slowdown was coming and it could hit earnings? Are we getting the revisions maybe that we were thinking we were going to get?
Damian Fernandes: Yeah, we’re definitely getting the revisions. So going into– the expectation going into this third quarter was where, still, people had marked $230 in earnings for the S&P. That’s down to 223, probably headed lower. I think where there’s going to be a surprise in this is that the expectation for next year is still sitting at, I don’t know, 240, 237 in earnings. That factors in an 8%, 9% earnings growth. If we’re discussing a recession, and actually economic growth being negative, that’s what a recession is, and the estimates are still calling for high-single digits earnings growth, something doesn’t feel right. You can’t make lemonade without lemons. If you don’t have economic growth, you’re not going to get the earnings delivery. So I think and what happens is most of the analysts adjust their numbers after Q4 reporting. So you owe end late. So I think as the year progresses and we’re almost there, you’ll see sequential ratcheting down of earnings numbers. And I don’t know where we’re going to end up. I just do know that the earnings numbers as they are right now are– they’re almost make believe. Like, you have to really believe in– that like in a no-recession scenario, a massive stimulus–
Greg Bonnell: The best-case scenario, inflation gets tamed, the economy doesn’t go off a cliff, everyone’s happy, and we keep our jobs.
Damian Fernandes: And maybe China announces a massive stimulus program that–
Greg Bonnell: Oh yeah, let’s add another one in, and suddenly we’re smiling.
Damian Fernandes: Yeah, well that’s what it would take because we’re talking about sequential growth. We already know growth is slowing in a real-time basis. You just look at the metrics and you look at housing here housing– the tip of the spear of rate increases — auto loans, housing activity, that’s a train wreck, right now in real time. And so all of the earnings associated with those major industries are already pulling back. So yeah, I think it’s a little bit of fantasy to the current earnings estimates for next year. Does that make me bearish? No, because we’ve — peak to trough, we’ve already had a 20% correction. There’s been a realization that those earnings numbers are probably going to get revised down.
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