Earnings and Powell. This is it, the biggest week of the third quarter, with the most important earnings and the Federal Reserve meeting that will set the tone for the entire second half of the year. For the Fed, the problem is no one is quite sure what version of Jay Powell will show up for the press conference on Wednesday. Will it be Jay Powell the fire-breathing inflation slayer, or the Powell that sees signs inflation is easing, or someone in between? For Julian Emanuel at Evercore ISI, the consumer price index at 9.1% means Powell must be "resolutely hawkish," but he will use the strong labor market and strong retail sales report to argue that the economy can "take it." In other words, Powell will argue that we have to keep hiking but the hope is the economy will remain strong. What bulls desperately want is for Powell to undercut the case for a major recession. But he can't do that yet. If he talks about weakening growth and economic momentum slowing (which we saw on Friday with the Flash Services PMI), the bulls will seize on that, but he doesn't want to sound premature. He needs visibility on the extent of the economic slowdown, and, unfortunately, Powell is not going to be able to tell us that on Wednesday. Powell certainly won't talk about a pause in rate hikes at the press conference, but the bulls are already arguing that the Jackson Hole conference (August 25) might be the opportunity to note that inflation is improving and the economy is indeed slowing, arguing for a pause in the rate hikes later in the year. Tech reset Meantime, on Friday we saw a "tech reset." The Flash Service PMI showed contraction, and tech stocks, which had been on a tear, sold off. That's the problem with trying to buy growth stocks prematurely. This summer we are going to oscillate between the slowdown is going to be mild, or the slowdown is going to be a lot more serious. Apple and Microsoft are the most important earnings this week. Everyone is afraid of a slower spending environment and the effect of the strong dollar, yet bulls are still insisting that iPhone demand will hold up better than feared. Expect to hear a lot about managing expenses and bulls spinning forward to a better fourth quarter and 2023. Dan Ives at Wedbush is in that camp: "As of now we believe iPhone demand is holding up slightly better than expected...That said, the Street is well aware of weakness this quarter and we believe ultimately is looking past June numbers to the September and December quarters with all eyes on the iPhone 14 production/demand cycle for the Fall staying on track," he said in a note to clients last week. Like everyone, he is hedging his bets but arguing the Street is well aware a slowdown is under way: "In a shaky macro there will be many casualties as a slower spending environment is on the horizon with darker storm clouds," he said. Earnings not yet reflecting recession The problem with this is that earnings are tangled up in the severity of any downturn. The buzzword from the bulls last week was a "mild" recession that would slow but not derail earnings growth. "In a bear case scenario, say a garden variety type recession, a 10-15% decline in earnings is a reasonable expectation," LPL Financial Equity Strategist Jeffrey Buchbinder noted in a recent note to clients. He's right: mild recessions tend to produce modest downturns in earnings, which usually snap back in a year or so. Earnings during mild recessions Early 1970s down 13% Mid-1970s down 15% 2020 down 13% Source: LPL More prolonged recessions tend to produce worst results. Earnings during severe recessions 1990 down 37% 2001: down 54% 2007-2009 down 91% The problem is, S & P 500 earnings as a whole are not reflecting any kind of recession, mild or severed. Earnings are still expected to be up 9.2% this year and 8.6% next year, according to Refinitiv. The bulls keep countering by arguing this is not an accurate picture. Earnings estimates for the growthier parts of the S & P — technology, communication services, and consumer discretionary — have come down significantly since April 1 (the start of the second quarter), while estimates for Energy profits have tripled since then. The dramatic increase in energy profits is skewing the earnings picture, they argue. True enough, but two sectors most exposed to the global economy, technology and industrials, are expected to see earnings up 7.4% and 36.3%, respectively. That's not exactly a recession, mild or otherwise.