For Whom the Earnings Bell Tolls

Friday Reflection | September 30, 2022

“Any man’s death diminishes me, because I am involved in Mankind; And therefore never send to know for whom the bell tolls; it tolls for thee.”¹

Ernest Hemmingway’s classic, For Whom the Bell Tolls, offers a reminder about the interconnectedness of all people – especially during times of war and conflict. As we attempt to move beyond the pandemic and understand the wider ramifications of the invasion of Ukraine, the question facing investors in the short term is how to interpret the interconnectedness of the broad economy when presented with quarterly earnings data from a single company.
 
The current quarterly earnings season is underway with FedEx, Nike, and CarMax all reporting recently, and hundreds more companies expected to report in the next few weeks. Pessimism has been the prevailing sentiment in response to these early reports. Despite a strong one-day rally on Wednesday, the S&P 500 fell to a new 2022 low on Thursday, and the Nasdaq Composite has effectively retreated to its June low as well.
 
Next week we will publish our quarterly market commentary and will zoom out to reflect on the overall arc of the market. This week, we are going to zoom in on a few recent earnings announcements that highlight the current challenges facing investors and companies.

While the Fed has driven many of the market headlines this year, it was FedEx that spooked markets with its latest earnings guidance. Rarely does one corporate press release have such a broad impact on the market, but the company is considered a bellwether since it has extensive data on the pace of global business activity and shipments.
 
FedEx stunned investors last week when it reported quarterly earnings earlier than expected, warned about slowing cargo shipments, and withdrew its full-year profit outlook. Their earnings were $3.44 per share for the quarter, falling short of analysts’ expectations of $5.10 per share. The company also announced it will reduce cargo flights, temporarily park aircraft, and close 90 offices. The stock plummeted following the news and is down more than 25% in the past two weeks. It is worth noting that their corporate rival, UPS, has not experienced similar declines and actually reiterated its own full-year earnings forecast earlier this month.
 
Investors are attempting to assess whether FedEx’s issues are a company-specific problem or a red flag for the broader economy as shipments slow down. Either way, the rapid selloff highlights investors’ current skittishness amidst continued rate hikes and recession worries.

Nike is another major company with a disappointing message on their quarterly earnings call, albeit for different reasons. Unlike FedEx, Nike beat analysts’ estimates for revenue and earnings in the prior quarter but warned that profit margins are likely to slow in coming quarters.²
 
Despite proactive planning, Nike faces challenges as the economic landscape has shifted this year. Like other retailers, Nike has experienced supply chain disruption in recent quarters that have increased shipping costs and extended shipping timelines. As delivery times and consumer demand were both rising, Nike ordered inventory earlier than usual and in larger quantities so they wouldn’t be caught flat-footed. By the time those extra shipments were arriving, consumer demand was slowing amidst inflationary pressures on household budgets. The result is that Nike’s inventory grew by +23% last quarter, and a portion of that will now need to be discounted in order to be sold – a problem many retailers may be facing as we approach the holiday season.³
 
Nike also faces headwinds from a stronger US dollar since it earns more than half of its revenues outside North America. The surging value of the dollar is expected to dampen earnings because international sales represent less revenue when companies translate them back into a stronger dollar. There is a direct, inverse correlation between the dollar and earnings for companies in the S&P 500. The reverse is also true that when the dollar eventually retreats from current highs, it will be a tailwind for companies with overseas revenues. For now, the dollar’s value continues to rise. The consensus forecast for aggregate 2023 earnings per share at S&P 500 companies has fallen almost 4% in the past three months.⁴ A stronger dollar is part of the explanation, in addition to waning economic growth.

The Federal Reserve’s aggressive trajectory of rate increases is intended to slow down the economy (ideally while avoiding a recession) in order to get inflation under control. Industries that rely on loans or financing are disproportionately impacted. The most obvious example is the housing market – and with the average rate on a 30-year fixed mortgage reaching 6.7% this week, its highest since July 2007, there is mounting evidence of a dramatic decline in sales and sale prices.⁵
 
Beyond housing, perhaps the second most impacted industry is auto sales. Used-car dealer CarMax reported its quarterly earnings this week – and failed to meet Wall Street’s expectations on nearly every metric. The ability of potential buyers to afford vehicles has become a challenge, with rising interest rates on loans and falling consumer confidence. Additionally, the company said their selling, general, and administrative expenses increased 16% in the quarter, due to increases in staffing, wage pressures, and investments in technology.⁶ The stock price declined significantly following the earnings announcement. One analyst reported that “CarMax has reminded Wall Street that parts of the economy are already in a recession, and the affordability challenges highlighted by the company are only going to get worse as Fed tightening continues to impact the economy.”
 
Investors are searching for clues about the direction of the US economy over the next few months, and CarMax’s earnings put a dent in the nascent optimism that had been building.

These examples could be written off as company-specific issues; they represent only three earnings reports out of the thousands of companies that make up the US stock market. Management teams at other companies may have been more successful in managing their inventory, hedging their currency risks, or proactively reducing costs ahead of slowing consumer demand. Those companies will be better poised for a strong recovery, but in the short term will likely be pulled down as members of the collective economy.
 
For the long-term investor, we expect that buying opportunities will be emerging as prices overcorrect on the downside. Patience will be required as volatility is likely to persist in the near term. We continue to rebalance client portfolios and take advantage of tax loss opportunities as prices adjust downward amid global economic weakness while maintaining exposure to investment assets that will participate in future growth when our interconnected economy begins its next upward cycle.

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¹ The quote by John Donne inspired the title of Ernest Hemmingway’s classic novel published in 1940. The quote was originally written as prose, as part of Donne’s 1624 work titled Devotions Upon Emergent Occasions, though it has morphed into a poem in subsequent years.

² Nike, Inc. Reports Fiscal 2022 Fourth Quarter and Full Year Results Nike Investor Relations

³ Nike shares fall as overstocked inventory weighs on earnings CNBC

⁴ FactSet

⁵ Mortgage Rates Hit 15-Year High as Markets Brace for More Fed Action Barrons

⁶ CarMax Reports Second Quarter Fiscal 2023 Results CarMax Investor Relations