US Earnings Season Half Time, Fed Fund Policy Odds

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US Earnings Season Half Time, Fed Fund Policy Odds

Two “Data” items today:

Topic #1: US corporate earnings, with just over half (56 percent) of S&P 500 companies having reported Q4 2021 results. Three points here, using FactSet’s latest data (link below):

First, here is the latest report card for Q4 results-to-date:

  • 76 percent of reporting S&P 500 companies have beaten Wall Street earnings estimates. That is in line with the 5-year average but below the 83 pct beat rate of the last year.
  • The average earnings beat is 8.2 percent above consensus. That is below the 5-year (8.6 percent) and 1-year (15.7 percent) averages.
  • 77 percent of reporting companies have beaten Wall Street revenue estimates. That is essentially in line with the 1-year average (78 pct) and well ahead of the 5-year average (68 percent).
  • The average revenue beat is 2.8 percent above consensus. That is well above the 5-year average (1.5 pct) but below the 1-year average (3.5 pct).

Comment: Q4 financial reporting season is the most “normal” one we’ve had in the last 2 years, with companies beating earnings expectations by amounts similar to long-run averages. That is not as exciting or reassuring as a blowout earnings season, to be sure. It is, however, good enough to say corporate profitability remains strong.

Second, Wall Street analysts have started to bump their Q1 and Q2 2022 estimates after getting more cautious at the end of last year and into the current earnings season:

  • At the end of 2021, the Street was looking for $52.36/share for the S&P 500 in Q1 2022 and $55.31/share for Q2 2022.
  • By the end of January 2022, those numbers had come down to $51.82/share (-1.0 pct) and $55.18/share (-0.2 pct) for Q1 and Q2 respectively.
  • As of last Friday (February 4th), the Street had increased their Q1 2022 estimate to $52.06/share (+0.5 pct) and their Q2 2022 estimate to $55.23/share (+0.1 pct).

Comment: earnings estimates need to increase to offset the damage done to valuations by higher interest rates, so the last week’s trend to higher Street numbers is very welcomed. It does, of course, need to continue in the week(s) ahead.

Third and last: Q4 earnings reports show that the Street remains too low on its 2022 earnings estimates:

  • As it stands right now, the S&P 500 is expected to earn $53.14/share in Q4. Since almost half the index is still to report, we can be fairly sure that the actual result will be at least 2 percent higher. That would be $54.20/share, and we think that’s conservative.
  • The Street’s numbers for Q1 and Q2 2022 (noted above) average to $53.65/share, or 1 percent less than Q4 2021’s most likely actual result.
  • It makes little sense to expect US corporate earnings power to erode from Q4 2021 to 1H 2022; in fact, it should improve modestly with continued economic growth and the pass-through of cost inflation.

Comment: barring an exogenous shock, Wall Street’s earnings estimates can and should continue to trend modestly higher. There is enough of a buffer here between what we know (Q4 results) and what’s expected (Q1 and Q2 2022) to make that happen. Wall Street analysts are a cautious bunch (we did that job all through the 1990s), so it may take some time but the trend is moving in the right direction.

Final thought/Takeaway: if earnings are fine, why are US large caps churning rather than plodding higher? The answer is Fed policy and interest rates. There’s nothing inherently “wrong” going on in near term corporate fundamentals. Which brings us to the other part of “Data” today …

Topic #2: Fed Funds Futures’ current odds on 2022 interest rate policy and, separately (sort of), the latest on 10-year Treasury yields. Friday’s Jobs Report had a measurable impact on both markets:

First, the odds of a 50-basis point increase at the March meeting rose last week:

  • Fed Funds Futures prices impute a 34 percent chance of the Fed lifting off from zero interest rate policy with a 50 bp move.
  • A week ago, the odds of a 50 bp move were just 9 percent.
  • As we noted last week, the Fed has not started a tightening cycle with a 50 basis point change in policy rates since at least 1990, so such a move has no historical precedent in modern (i.e., post-Volcker) times.

Second, odds continue to increase that the Fed will raise rates in 2022 at a speedy tempo:

  • December Futures put the highest odds on 5 rate hikes (to Fed Funds of 125 – 150 bp, 31 percent probability) or 6 rate hikes (to 150 – 175 bp, 33 percent odds).
  • The odds of 7 25-basis point hikes (i.e., one at every meeting) this year have risen in the last week, to 16 percent from 6 percent last week.

Third and last, Friday saw 10-year Treasury yields climb to 1.92, their highest post-pandemic crisis levels to date. The chart below, which shows the last 5 years of 10-year Treasury yields, puts this in historical perspective.

  • It has taken almost 2 years to climb out of the hole created in 2020 and there have been fits and starts along the way.
  • Friday’s close is on par with the highest yields of 2H 2019 (1.94 pct high), but those were depressed due to concerns that the then-ongoing US-China trade war would cause a recession.
  • Prior to that, 10-year yields were reliably between 2 and 3 percent.

Takeaway: 10-year yields are close to signaling that the US economy really is back to its pre-trade war, pre-pandemic self. For better or worse, that also means Fed policy needs to normalize quickly and Futures say that will happen soon.

Sources:

FactSet Earnings Insight Report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_020422.pdf

CME FedWatch: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html