Welcome to another issue of the Weekend Edition.
Thank you to all who’ve read and subscribed to the newsletter this week!
Here’s what we cover this week:
Market Recap - Fed Minutes
Sector Focus - Banks: Earnings Preview
Earnings of Week - Conagra, Constellation Brands
The Week Ahead - Economic & Earnings Calendar
Closing Thoughts - Caution with Earnings!
Let’s dive in ⬇️
Market Recap - 04 April to 08 April, 2022
It’s been an odd week in the market and we’ve seen a lot of choppy price action. Next week will be a shorter trading week with markets closed on Friday, April 15. But, I’m glad earnings season kicks off on April 12. There will be something better to focus on.
It would seem like the major events this week were the Fed Speakers and the FOMC minutes on Wednesday. Fed Vice Chair Lael Brainard spoke on Tuesday in quite the hawkish tone about aggressive rate hikes and rapid balance sheet reduction. She was not bluffing!
FOMC Meeting Minutes
The Bottom Line: A 50 bps (0.50%) hike is on the table for the next meeting and a possible plan to reduce balance sheet by $95 billion ($60B treasuries + $35B Mortgage-Backed Securities) per month.
Analysis: While these are still just discussions, it is a guide to what the Fed will finally decide. The last time the Fed decided to do something resembling QT during the 2017-2019 tightening cycle, they’d agreed on a maximum of $50B ($30 treasuries + $20MBS) and it took them up to a year to reach this level, starting out at $10B/month. They reduced almost $650B over the course of 2 years.
This time however, they’re discussing a timeframe of 3 months, which works out to just over $1 Trillion reduction in 1 year’s time. This is quite aggressive and is sure to send shockwaves through the system. Whether they will ultimately be able to follow through with this plan is another question altogether. It didn’t work so well last time and they had to stop and reverse course.
As for the nature of the reduction - much of the treasuries have maturities less than a year and a large proportion can be redeemed at maturity. But the MBS, have longer maturities and fewer prepayments (higher rates mean fewer people refinancing mortgages). So the bulk of these will be “outright sales”. Also given the rising rates, they’re sure to be selling these at a loss.
Excerpts from the Minutes:
“Many participants noted that one or more 50 bp increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified.”
“all participants agreed that elevated inflation and tight labor market conditions warranted commencement of balance sheet runoff at a coming meeting, with a faster pace of decline in securities holdings than over the 2017–19 period.”
“Several participants remarked that they would be comfortable with relatively high monthly caps or no caps. Some other participants noted that monthly caps for Treasury securities should take into consideration potential risks to market functioning. Participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate. Participants also generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warrant.”
Sector Focus - Banks: Earnings Preview
It’s really helpful that earnings season starts with the Banks. The Banks give us such a good way to understand the state of the current economy and insight into where the economy is possibly headed.
I expect the banks to have a tough quarter and to paint us a not-so-pretty picture of things to come. I know it all sounds like doom and gloom but, that’s the world we live in and it’s better to be prepared.
Looking back to last quarter, there were some hits and misses. Most of the bank stocks declined on earnings with JPM and GS gapping down quite significantly.
The big news was the rise in Operating Expenses because of higher wages. But, also the lending portfolio was faltering ever so slightly. On the positive side, Credit Loss provisions came down significantly and fee based income from trading & capital markets increased substantially.
Year-to-date however, the bank stocks haven’t been so hot. With the yield curve flattening into inversion, banks have been under pressure and particularly the lending banks, because they tend to do better when the long end of the curve goes up.
Here’s a slightly more in-depth review of JP Morgan and Wells Fargo from last quarter.
What does this earnings season have in store for the Banks?
Just too many negatives - pressure on results during the quarter and a gloomy picture of things to come.
Credit growth is slowing and we’re likely to see lower loan origination on the auto loan and mortgage loan sides. Auto loans have been weak as it is because of the lack of supply and highest costs for second hand cars. And, as I’m sure you’ve heard many times over, 30Y Mortgage Rates are now c.5%.
Investment Banking has taken a hit due to the geopolitical situation and analysts estimate a decline of 36%.
M&A, Syndications and IPO activity have all been down for the quarter. Although, I suspect we will see an increase in M&A in H2 as smaller companies get taken over, and more activity arising out of the distress debt market.
Trading Income is also likely to take a hit, with analysts expecting an 18% decline. Wild swings in Commodity prices during the quarter and the Bond rout we saw in Q1 is sure to create pressure.
According to Refinitiv, “Net income for the six biggest U.S. banks will be down about 35% from a year earlier”.
Credit Losses - The geopolitical situation has hit banks, as expected. JPM already announced c. USD 1B in losses. But the interesting discussion will be on the outlook from the conference calls. With costs already at such high levels, and increasing interest rates, banks will likely see more pressure of consumer defaults. This is something worth keeping an eye on.
Cost Pressures - We already saw cost pressures increase because of higher wages last quarter and this is not slowing down, according to BLS.
And finally, here’s a quick reminder I put out every earnings season on the ratios and key metrics to look at and how to interpret them.
Earnings of the Week
We had few Food & Beverage companies report this week among the Consumer Staples. The Staples have been faring well given the current macro environment but we’ve had a mixed bag of results.
Constellation Brands - STZ - (Alcoholic Beverages)
STZ is back to form beating EPS and Revenue estimates. EPS growth was +30% and Revenue growth was +8%, driven primarily by beer sales, in the Coors (+9% QoQ) and Modelo (+17% QoQ) brands.
Despite inflation, the company’s pricing power on premium brands has helped them post a 2.4% YoY increase in margin to 39.2%. This was driven primarily by the wine and spirits segment which increased margin by 2.8%, after the company decided to divest the lower cost brands in this segment.
They also announced a $500m accelerated share buyback. Their recent partnership with Coca-Cola and potential merger with Monster Beverages makes this stock a good prospect for a long term buy.
Conagra - CAG - Packaged and Frozen Foods - SlimJim, Hunts, Birds’ Eye
CAG met EPS estimates and beat on revenues but inflation is still hurting them. Revenues grew 5.1% QoQ but Operating Margin decreased 3.87% to 12.3%, ultimately hitting the bottom line. Even last quarter, the company discussed inflation headwinds and this is playing out in earnings.
While they guided down, the company is still optimistic because they have new offerings, and are increasing prices to cope with inflationary pressures. The CEO’s view is that with prices rising across the economy, people will stop going out and start eating at home again, driving up their sales, much like during the pandemic. There hasn’t been a massive increase in volume in their unit sales and it remains to be seen whether their stance on increasing prices works out in their favor.
While the company does belong to the Consumer Staples sector, I’m not entirely convinced that their strategy will drive strong growth, this year.
The Week Ahead
Economic Calendar (time in ET)
Closing Thoughts - Caution with Earnings
It’s not just the banks that will have a tough time this quarter. Last week, we took a look at the Consumer Discretionary Sector and Retail, and the likely effects of a tightening cycle amid high inflation. Comps vs. a year ago will be challenging and I know I sound like a broken record when I say this but, it’s something to keep in mind.
I will never in good conscience recommend that anyone plays earnings. Remember Netflix and Facebook from last quarter? We probably knew they were headed for disaster but, who knew by how much. Comparable companies are also not a reliable indicator. FB tanked but SNAP fared quite well.
So unless, you’ve really been following a company and know what you’re doing, I’d say wait till the initial gap up or down, as the case may be. Even then, I’d be cautious because the market can and will surprise you.
Here’s wishing you a happy weekend, safe investing and happy earnings season.
Ayesha Tariq, CFA
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None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have a long position in $FAS as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.