Letting the Air Out

With the dust settling on a busy week of earnings reports, markets have turned increasingly bearish. The S&P 500 now finds itself in correction territory, down just over 10% from the 52-week high set in July. With roughly half of the S&P 500 reporting, earnings have beaten expectations by a little over 7% and just under 80% of reporting companies have exceeded their earnings forecast. Despite these impressive numbers so far, the market’s reaction has been cold.

Mega cap stocks META and GOOGL were priced for perfection heading into their earnings reports. While they each surpassed expectations on the top and bottom line, the results were not blemish-free and investors punished them. Curiously, these reports sit against the backdrop of blowout economic growth in the third quarter. Taken together, market participants may be starting to question the upside from already strong earnings and economic conditions.

Real economic growth increased at a blistering 4.9% rate in Q3, well above the 4.5% consensus estimate. Growth was fueled by robust consumption, private inventory buildup, and government spending. Yet, persistent declines in real disposable personal income cast doubt on the durability of consumers. Inflation is on a downward trajectory, but it is still eating into purchasing power at its current levels. As savings diminish, consumers are borrowing more and at much higher interest rates. The federal government’s deteriorating fiscal situation also calls into question the sustainability of more public spending. It is likely we have witnessed the peak of economic growth for this cycle.

Despite strong numbers on the surface, earnings reports are generally not sitting well with the market. Between the lines, market participants may be picking up some hints of weakness. More likely, however, participants are wondering what the catalyst is from here. With pressure from rates rising and savings falling, it is hard to argue that consumers and businesses will be in a better position tomorrow than they are today. The air is coming out of earnings multiples for some of the biggest weights in the market.

With volatility rising, we are reminded to focus on what we can control. We know that there is a historically strong relationship between dividend growth and price growth. Regardless of short-term movements in the prices of stocks, those that are growing their dividends at a steadily high rate should be rewarded in time. Our efforts are devoted to finding and owning the companies that can do so.

Thanks,
Preston May, CBE®
Research Analyst