Poor earnings in the S&P 500 play into the Fed’s hand

(Bloomberg) — Was it good or bad this week as Alphabet Inc. told investors that ad demand, which has helped grow sales by 50% in two years, is starting to slow? Depends on what you mean by bad, and there’s rarely any argument over definitions that are more for markets and economics.

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Obviously, it was bad for Google’s parent company shareholders, who saw $70 billion wiped out in one fell swoop. Tech bulls in general took a dip, with the Nasdaq 100 dipping 2.3% on Wednesday. And the news did not help anyone hoping the economy would avoid a recession, given the notoriously forward-thinking aspect of the advertising market.

But these target groups are not all. Another reason is people’s concern that inflation remains beyond any ability to contain it. This includes Jerome Powell, whose Federal Reserve is doing everything in its power to curb spiraling prices.

For them, it can be argued that bad corporate news has become good – or at least a necessary evil – when taken as a signal of falling demand, which is ultimately positive for economic stability and one day for markets themselves. It’s a role long played by macro data points – weak GDP print, for example, can sometimes ignite a market rally – but rarely by micro data points.

“It’s a feature, not a bug,” Art Hogan, B. Riley’s chief market strategist, said over the phone. “Nobody ever wants to live in a world where bad news is good news, but the bad news we just got from some of the largest market-cap companies in the S&P 500 was necessary. It has to be said that things are slowing down – the Fed’s rate hikes have to work.”

As much as investors love a good earnings report, Corporate America’s money machine has disproportionately fueled the inflation boom. A study by Josh Bivens, director of research at the Economic Policy Institute, found that as price pressures mounted in 2021, more than half of the increase was due to rising corporate profit margins. Labor costs contributed less than 8% – a reversal of the dynamic from 1979 to 2019.

That investors should pay a price for the world’s bigger problems was a recurring theme in 2022. The Fed’s anti-inflation campaign is threatening the economy, sanctions on Russia have sent energy markets into spasms – tears were few when the shares suffered as a result.

A similar dynamic is beginning to take hold in what was previously a bastion of hope for the stock group — earnings. Nearly a quarter of the companies reporting results this season have missed estimates, which are high by historical standards, data compiled by Wells Fargo’s show. The estimates themselves also reflect serious pessimism built into the assumptions. As recently as May, S&P 500 corporate earnings were forecast to rise 9.7% in the third quarter. The expected gain was 2.5% last week.

Convincing investors that the blows involved are good for humanity is a tall order. The pain has rarely been worse for a holding company that is suffering earnings shortfall, with the average penalty this earnings season exceeding 4%, the worst in a decade.

At the same time, last week’s market contours could fit with a bit of a twist a thesis that says earnings troubles are seen as something other than bad news by the broader investor community. Bond yields fell over the five days, with one of the major swoons occurring around the time Amazon reported, and both the Dow Industrials and an equally weighted version of the S&P 500 rose sharply.

“It may be uncomfortable, but some see it as a necessary evil,” said John Stoltzfus, chief investment strategist at Oppenheimer & Co. I think it is.”

microsoft corp posted the weakest quarterly sales growth in five years, weighed down by a strong US dollar, which rose sharply on the back of US Federal Reserve rate hikes. Alphabet said advertising growth for its Google subsidiary has been hurt by inflation. Amazon.com Inc. forecast weaker sales for the holiday quarter as the company struggles with consumer spending cuts amid economic uncertainty. And Texas Instruments Inc. — whose chips go into everything from home appliances to rockets and is used as a gauge of demand across the economy — fell after its forecast fell short of analysts’ estimates.

From a corporate perspective, bad news isn’t good, but from an economic perspective, it can be seen in more positive light, says Anthony Saglimbene, global market strategist at Ameriprise, because it means the Fed is cooling the economy.

“From a profitability perspective, companies want to navigate the S&P 500 as best they can,” he said in an interview with Bloomberg’s New York headquarters. “That’s going to get harder the more economic activity slows.”

–Assisted by Lu Wang and Isabelle Lee.

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