Making sense of the markets this week: August 7
Do earnings matter in 2022? Will Canada follow the U.S. into a recession? Plus other fascinating market fodder.
Do earnings matter in 2022? Will Canada follow the U.S. into a recession? Plus other fascinating market fodder.
This week, Cut the Crap Investing founder Dale Roberts shares financial headlines and offers context for Canadian investors.
The stock markets are silly. This earnings season is likely the most meaningless as well.
The only thing that matters is inflation—and the fight against inflation. And, yet, the stock and bond markets keep guessing and guessing again.
Don’t get me wrong; I’m interested in the earnings reports. It’s where we get to see how our companies are performing. It’s like reading the economic tea leaves as companies provide details on their customers and the trends within their sector. But do the earnings reports matter much (or at all) in mid 2022?
Earnings are backward looking. The reports are old news before it’s even considered news. And yet, the markets react to the earnings. Some days they cheer. Some days they get a serious case of indigestion.
The markets are supposed to be forward thinking. And the earnings reports tell us very little about the future. What economic environment is going to stick around for the next year or three?
How hard does the Federal Reserve (and other central bankers around the world) have to whack the consumer to kill demand and inflation? That will determine the economic environment that we get. In turn, the economic quadrant will dictate the performance of sectors, and the future of company earnings. It’s the future that matters—to state the obvious. We are in a period of economic transition.
Since mid-June, the U.S. markets are recovering, often buoyed by solid earnings reports, and the hypothesis that the Fed will soften up on its rate hikes.
This “Making sense of the markets” column will offer a quick primer on “Fed speak” and the dovish (or hawkish) tone we’re seeing right now.
The central bankers can rattle the markets with comments like:
“[The Fed is] nowhere near almost done. We have made a good start and I feel really pleased with where we’ve gotten to at this point, [but] people are still struggling with the higher prices.”
—San Francisco’s Mary Daly
Central banks are attempting to make an economic soft landing. And here are the acrobatics required.
Economic growth is already in decline. There are many signs that inflation is about to recede. Central banks have to apply the right amount of pressure (via rate increases) to the gravity of the economic and inflationary decline, already in motion.
Think of inflation as a ball attached to a long elastic band in the sky, and it’s falling. The goal is to apply just enough pressure to increase that rate of descent, with the objective being that the ball stops just short of crashing into the ground. And then the ball has to bounce around and settle within a desired range. The central bankers’ flight plan is to keep inflation at a 2% to 3% level.
This is where physics and economics collide. It is an almost impossible task for central bankers. That’s why an economic soft landing is about as rare as a Stanley Cup parade in Toronto.
Buy hey, anything is possible.
Earnings show how certain sectors and stocks are performing during the current, ongoing inflation and stagflation environment. We can also learn from the companies’ commentary and guidance.
Last week, Kyle wrote up a very informative roundup of earnings on both sides of the border.
Out of the gate, let’s look at oil and gas producers.
Energy is known to be the inflation hedge with respect to types of stocks. The energy stocks are sticking to the script. (Numbers in this section are listed in Canadian currency.)
Canadian Natural Resources (CNQ/TSX) is often touted as one of the best-run companies in Canada. It is a rock in a very volatile sector. Earnings for the quarter almost tripled from a year ago, to $3.00 per share. Its free cash-flow almost doubled to CAD$5.896 billion. The free cash-flow enables the dividend increases. In March, CNQ raised its quarterly dividend by 28%. In the earnings report it announced a special dividend of $1.50 per share. As I have long suggested, oil and gas companies are free cash-flow gushers.
Tourmaline (TOU/TSX), which I also own, announced a special dividend of $2.00 per share after reporting record free cash-flow levels.
Suncor (SU/TSX) generated record adjusted funds from operations, approximately $5.3 billion—that’s more than a double from a year ago. Operating earnings increased to $3.814 billion ($2.71 per common share) in 2022’s second quarter, compared to $722 million ($0.48 per common share) in the 2021’s Q2. The company’s net earnings increased to $3.996 billion ($2.84 per common share) in the second quarter of 2022, compared to $868 million ($0.58 per common share) in the same quarter in 2021.
Of course the energy sector is cyclical and the stock prices will get hit hard with any economic weakness, or if we enter a recession. Just as with investing in bitcoin, be prepared for wild volatility.
In writing this column, I have always been enthusiastic about the U.S. defensive stock CVS Health (CVS/NYSE). And I wrote about it in this column about the recession-ready portfolio. Here’s an excerpt from that. (Numbers below for U.S. stocks are listed in U.S. currency)
“I’ve been more than happy to add to my healthcare stocks with the likes of CVS Health (CVS), Johnson & Johnson (JNJ), Abbott Labs (ABT) and Medtronic (MDT). Retailer Walmart (WMT) is known as a recession-friendly or recession-proof stock. In recessions, consumers flock to low-cost retailers. Walmart is the king of low cost. I’m happy to stock up on Walmart.”
Pharmacy retailer CVS Health shares recently reached a three-month high, recording the biggest intraday gain since April 2020. The company raised earnings guidance for 2022 as its business segments exceeded expectations, leading to a solid overall revenue beat for the quarter.
Here’s a 1-year chart for CVS.
The stock certainly came under pressure, falling in sympathy with the market. IMHO, that provided a wonderful opportunity to pick up more shares in a company that will see even brighter days ahead. And it offers an attractive valuation. For those of us who were already holding this stock, we have a rare robust winner over the last year.
By way of consumer-staple stocks, we can check in on the health of the consumer.
Colgate-Palmolive (CL/NYSE), which I hold, offered some very good results in its latest quarterly report. It beat on earnings, and on revenue of $4.48B (+5.2% year over year). The company raised its organic sales growth guidance for full year 2022 to 5% to 7%.
On the state of the consumer, chairman, president and CEO Noel Wallace shared this perspective on an earnings call:
“You continue to see great pretty good vitality at the consumer level, emerging markets growing mid-single digits, obviously some slowdown in the developed world, particularly out of Europe.”
And on inflationary pressures and supply chains, he said:
“But we are still dealing with a very difficult cost environment. We now expect $1.3 billion in raw material and packaging inflation, with higher logistics costs as well. Foreign Exchange has become a bigger headwind since our first quarter earnings release.”
The takeaway for me is that we see the weakening of the consumer in developed markets. Global conglomerates are still experiencing inflation pressures, supply chain disruption and currency headwinds. Foreign earnings are worth less when the U.S. dollar is strong.
The U.S. has entered a technical recession, described as two successive quarters of economic decline. Canada is still experiencing some modest growth. But what springs to mind is the common expression.
“When the U.S. sneezes, Canada catches a cold.”
I thought it might be the case that Canada always follows the U.S. into recessions. I checked in with my friends at BMO ETFs and here’s basically what they wrote me back.
The two economies are highly synchronized. Here’s a chart that demonstrates the economic link and gravity. They move together. The white line represents the U.S., and the blue line represents Canada.
Recessions do not occur very often because expansion usually occurs in the economy. Case in point: Canada has experienced a total of five recessions since 1970 and 12 since 1929. Recessions usually last between three to nine months. The most recent one for us, the 2008/09 recession, lasted seven months. All recessions in Canada since 1970 occurred at the same time as the economy of the United States experienced a recession, showing that the two economies are highly synchronized.
However, the extent of a recession in Canada is determined by many factors, depending on which parts of the economy are in decline. For example, the Canadian economy is very sensitive to activity in natural resources such as oil and gas, mining and lumber.
And from my perspective, the real estate market has become a leading growth sector for Canada. The Bank of Canada (BoC) has signaled it will fight inflation, taking the wind out of the sails of consumers by deflating the Canadian real estate bubble. It’s an easy target.
In its latest housing report, RBC says the BoC expects home sales (volumes) to fall 23% this year and 15% next year, eventually culminating in a 42% from the start of 2021, according to RBC’s assistant chief economist Robert Hogue. That’s a larger decline than any of the past four national downturns (-33% in 1981/82, -33% in 1989/90, -38% in 2008/09, and -20% in 2016 to 2018).
The air is quickly coming out of the market.
Stay tuned. I am writing an article looking at the affordability level for wannabe homebuyers for MoneySense. We have the battle between falling home prices and the borrowing costs that have hit the roof.
Since the beginning of 2022, I’ve calculated that variable mortgage rates in Canada have increased over 380%. 5-year fixed rates have gone up by about 65%. Since peaking at $816,720 in February, the national average house price has fallen 18.5% to $665,849 in June. More price decline reports are on the way for July data.
If Canada does head into a recession, it may largely be thanks to the (necessary) popping of this massive housing bubble.
Continuing on the recession theme, here is a great post on global inflation and business activity from S&P Global. The main takeaway is that we have a slowing global economy. The U.S. leads the way on the recession watch, as it has entered a technical recession: two successive quarters of economic decline. Emerging markets shine as the bright spot. We also see some inflation pressures are in decline. That said, wage demands are increasing. Wage costs and energy costs can lead to sticky inflation.
Liz Sonders, of Charles Schwab, tweeted that you’ll see the sector returns for July and year-to-date. You might remember that U.S. stocks had the worst first half since 1962, but they are now attempting to fight back. U.S. stocks just had their best month since 2020, jumping more than 9%. And treasuries had the biggest losses since 1788 in the first half of 2022.
Energy and the defensives (utilities, consumer staples and healthcare) led the way. In writing for this column, I’ve long suggested retirees might consider a defensive posturing. (I did write about a stock portfolio for retirees on my own site.) Jonathan Chevreau and I are proponents of energy stocks as an inflation and stagflation hedge.
Also from Sonders, a look at the “super 7” (U.S. mega growth) and index returns:
In that tweet, you’ll see the drawdowns for major U.S. indices and the drawdown of average members (constituents) of each index.
And, yes, the Fed is hiking into gross domestic product (GDP) decline.
Investors clearly chose to cherry-pick Fed Chair Jerome Powell’s dovish comments and ignore his hawkish ones, suggested Ed Yardeni, president of sell-side consultancy firm Yardeni Research, wrote in a paid-service note to clients.
At times, investors decided the U.S. Federal Reserve may not go as high as predicted on interest rates. Yet there’s plenty of debate about whether this is the correct read of the Fed’s messaging last week.
No one would call you out for feeling like the market was experiencing a warranted rally. There are still a lot of commentators describing this as a bear-market rally.
These are strange times for the markets. Maybe this tweet says it all.
All that said and done, inflation is the maestro waving the magic wand at central bankers. The economy and company earnings will act accordingly.
As always, if you’re in the accumulation stage, keep adding new money according to your investment plan. If you’re in retirement or in the retirement risk zone make sure that you’re ready for anything.
Dale Roberts is a proponent of low-fee investing, and blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge for market updates and commentary, every day.
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Eric Parnell at Seeking Alpha offered a wonderful analogy for the inflation fight and finishing your medicine.
“In many ways, the Fed’s inflation challenge is similar to taking antibiotics to treat an illness. Even if the patient is feeling better, they must finish the entire course of antibiotics to eradicate the sickness. If not, they risk the potential for the illness to come back even worse than it was before. The same exact principles apply to the Fed’s inflation fight.”