SUMMARY: FDX issued reduced revenue and EPS guidance yesterday, saying that “Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the US,”. Economic activity is slowing along with inflation, and earnings estimates need to be revised lower as exceptionally high profit margins normalize. Negative guidance has been increasing since late 2021 and broke above its normal level in mid-’22.
After negative revisions to 2H22, flat to slightly lower profitability is all that is needed to reach full-year 2022 consensus estimates. If growth and inflation slow faster than expected, further negative revisions are likely in 2022. The larger issue is 2023 estimates, which imply a reacceleration of margins that is unlikely in a lower inflation, slower growth macro backdrop. The risk is a deep recession that requires aggressive negative revisions at the same time that macro uncertainty restrains multiples.
The need for further negative revisions and heightened uncertainty help explain the results of our latest investor survey (HERE). 65% of clients expect the S&P to fall at least -4% over the next six weeks (which includes much of reporting season). The median expected decline is -5%, but the distribution of responses is more interesting. More than a quarter of people expect a more than 10% market decline and 3/4ths expect at least a mild decline.
The negative market view is biasing most investors toward a Defensive allocation. Nearly half of respondents expect Defensive to lead compared to just 15% that expect Cyclical leadership. Financial conditions have retightened and are back near their tightest levels of the year. If they are tight enough to slow growth and reduce inflation remains uncertain.
Keep in mind that the Cyclicals are priced for a fairly dire outcome. Cyclical median PEs are at an all-time low relative to Defensive PEs. The macro backdrop still favors Defensive leadership, but the potential exists for a sharp Cyclical rebound if growth and inflation slow.
Full report below…
MARKET VIEWS: FDX issued reduced revenue and EPS guidance yesterday, saying that “Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the US,”. Economic activity is slowing along with inflation, and earnings estimates need to be revised lower as exceptionally high profit margins normalize. Negative guidance has been increasing since late 2021 and broke above its normal level in mid-’22.
2Q earnings reports were stronger than expected and much better than feared. Index level margins were steady Q/Q. After negative revisions to 2H22, flat to slightly lower profitability is all that is needed to reach full year 2022 consensus estimates. If growth and inflation slow faster then expected, further negative revisions are likely in 2022. The larger issue is 2023 estimates, which imply a reacceleration of margins that is unlikely in a lower inflation, slower growth macro backdrop. If a recession can be avoided (or if there is a mild one), then higher PEs can offset the decline in EPS. The risk is a deep recession that requires aggressive negative revisions at the same time that macro uncertainty restrains multiples.
The need for further negative revisions and heightened uncertainty help explain the results of our latest investor survey (HERE). 65% of clients expect the S&P to fall at least -4% over the next six weeks (which includes much of reporting season). The median expected decline is -5%, but there is distribution of responses is more interesting. More than a quarter of people expect a more than 10% market decline and 3/4ths expect at least a mild decline.
The negative market view is biasing most investors toward a Defensive allocation. Nearly half of respondents expect Defensive to lead compared to just 15% that expect Cyclical leadership. The sentiment setup for Cyclicals is becoming more attractive, and the market remains narrative driven (PEs, far more than fundamentals, are moving markets).
Financial conditions have retightened and are back near their tightest levels of the year. If they are tight enough to slow growth and reduce inflation remains uncertain. There is a narrow path of slower but not too slow growth that would suggest conditions are tight enough to put inflation on a Fed friendly trajectory that could be a catalyst for a Cyclical rotation. Data over the next few weeks and into early reporting season will determine if that rotation takes place.
Keep in mind that the Cyclicals are priced for a fairly dire outcome. Cyclical median PEs are at an all-time low relative to Defensive PEs. The macro backdrop still favors Defensive leadership, but the potential exists for a sharp Cyclical rebound if growth and inflation slow.
