Earnings aren't bad, but fourth-quarter forecasts are slipping. Here's what that means for the market

Published Thu, Oct 26 20238:56 AM EDT

The flood of earnings reports are hitting the half way mark. Results haven't been bad, but the macro is overwhelming everything, and fourth-quarter guidance is slipping. Here's a general rule for the stock market: earnings are the main determinant of stock prices in the long run, but in rare cases macro trends can overwhelm their message. That seems to be what is happening now. The market is obsessed with interest rates, which are moving in the wrong direction, and that is overwhelming a large part of the earnings story. What's it mean? On a short-term basis, the market is becoming almost uninvestible, at least until we see a peak in rates. Look at Meta today. Sales were up 23% year over year, but the stocck is down in premarket trading after the company said revenue would be a bit soft in Q4, whichs shows they are highly dependent on macro factors. Other big-cap tech names are reporting strong earnings, but they are either sold off on modest disappointments ( Alphabet on cloud ), or great reports are met with a shrug. Look at Microsoft: a strong earnings report , with robust growth in the cloud , and the biggest earnings and revenue beat since July 2021, according to CNBC's Robert Hum. A small number of enthusiastic buyers drove the stock up right at the open on Wednesday, to $346.20. But that was it. Sellers immediately came in and drove the price down to $340 in less than an hour. It's down Thursday in premarket trading. Earnings are OK, but the trend is down On the surface, this looks like a good earnings season. Overall third-quarter profits for the S & P 500 have been steady, according to LSEG, and are expected to show a 2.6% gain compared with the same period last year. That's slightly higher than where it was Oct. 1 (up 1.6%). Most of the big banks and insurance companies have reported, and overall financial earnings have been higher than expected (up 18.9% year-over-year vs. up 11.9% on Oct. 1). There's a lot to still like about earnings in other sectors. Many companies still have pricing power. We have seen that with insurance (Chubb), trash hauling (Waste Management), railroads (Norfolk Southern), hotels (Hilton), homebuilders (Pulte) and consumer names (Procter & Gamble, Sherwin-Williams, Coca-Cola, Pepsi, Kimberly Clark, Campbell Soup and J.M. Smucker). Also, lower or stable commodity prices were a tailwind for companies like Sherwin-Williams and Procter & Gamble. Another piece of good news: profit margins are relatively steady, at about 11.6%, about where it has been for the prior two quarters. On the negative side, some companies spoke of lower demand or lower volumes, including 3M, Pool, Winnebago and Corning. Soft consumer demand has translated into serious problems for truckers like Knight-Swift and other companies that have intermodal (trucking/rail) businesses. Overall, more good news than bad news. With earnings, however, it's the trend in the forward quarter that matters: is the trend up or down? In this case, it is starting to trend down, but not by much. Fourth-quarter estimates are expected to be up 9.1%, down from 11.0% on Oct. 1, and Q1 2024 has gone from 9.6% to 9.0%. That isn't a huge drop, but it is a change in trend. Earnings estimates have been stable for months, and that is now changing. One potential issue is that there are a lot of odd quirks in the earnings picture. For example, in Big Tech, the focus is understandably on Microsoft, Alphabet and Meta, but they are not the biggest players in the earnings game. The most is riding on Nvidia, which reports Nov. 21, one of the late reporters. The contribution to S & P earnings is huge: it reported earnings of 58 cents per share in the third quarter of 2022 and is now expected to report per-share earnings of $3.32, according to FactSet. It is not only the largest contributor to earnings growth for technology, it is the largest contributor to earnings growth for the entire S & P 500. FactSet's John Butters said that the earnings contribution is so large that if Nvidia is excluded, the earnings decline for the S & P 500 for the third quarter would go from down 0.4% to down 1.8%. So what's next? It's a very strange time. Consider: there is no imminent sign of a recession, yet stocks seem to want to price in a recession. Investors are trying to convince themselves that higher rates are finally going to cause a recession. They did that at this same time last year, and they were wrong. Very wrong. Consider: we are going into the seasonally strongest time of the year, yet the markets are drooping. Consider: the consumer still looks healthy. (American Express, a bellweather for spending, noted that U.S. cardholder spending was up 9%, Visa said the consumer was "resilient" and this morning Southwest Airlines said, "Thus far in fourth quarter 2023, overall demand for travel remains stable, including strong bookings to-date for the holiday travel periods.") Yet, consumer confidence has been down for two straight months. What it means for the stock market is this: rallies are not being bought with sufficient strength to make them last. An awful lot of people seem happy to just clip 5% coupons on their one-year Treasurys. The only good news: the "pain trade" — or thhe trade that would cause the most pain to the most participants — is for a modest rally in Treasurys and a stock rally going into the end of the year. What about earnings trending lower? Not a good sign, but the "macro" environment works in both directions. If Treasury yields stabilize or even move lower, that will be a more important factor than a slightly lower earnings environment. That still remains the most likely scenario. But the macro environment is making forecasting a very murky proposition.