by Franklin J. Parker, CFA
The Summary
- All eyes are on the Russia-Ukraine standoff. Meanwhile, this week, the march of data continues. Consumer confidence and PMI data post tomorrow. Jobless claims post on Thursday with personal incomes on Friday. All of these data points are important, especially initial jobless claims, which have ticked up recently. So far, the economy has remained fairly robust in the face of inflation and ongoing covid concerns. With the landscape rapidly shifting, however, investors are closely watching for a potential slowdown.
- Earnings season is coming to a close with 90% of the S&P 500 companies having reported. It is generally good news, with 78% of companies reporting earnings above expectations. In summary, the S&P 500 is on track to post 31% earnings growth, year-over-year. Technology, despite all of the hubub, has posted the most beats, and utilities have posted the fewest. Inflation is a hot topic on earnings calls, and remains a wildcard in coming quarters.
- My portfolio view has not shifted. I still see a rocky first half to 2022, with the drawdown likely lasting another 3 to 5 months, and possibly reaching down 15% to 20% from the recent highs in the S&P 500. The Fed has been a bit confusing in their messaging lately. There is talk of raising rates by 0.50% in March, though that has not previously been on the table. For investors, the Fed meeting in March represents a significant event, and is likely to push prices around—as are the few meetings after. Once markets have digested the new backdrop, I see a return to growth in the back half of the year.
The Details
I (and many others) have talked extensively about the rise of so-called “zombie companies” in recent years. Though there is no standard definition, a Federal Reserve report defines a zombie company as (1) does not make enough money to cover the cost of their debts, and (2) has negative sales growth. In other words, zombie companies have to constantly consume new investor capital to stay alive.
One consequence of Fed policy over the past 15 years has been to make it considerably easier for zombie companies to survive. That Fed report also shows that about 9% of publicly-traded companies in the US is a zombie firm (I have seen other reports that put the figure closer to 20%). Since these firms tend to be highly leveraged and dependent on ongoing easy money, these firms stand to lose the most (all?) as leverage becomes more expensive and easy cash begins to dry up.
To date, investors have been content to back companies with a strong narrative—even if cash and sales have been in short supply. We can expect this willingness to diminish as the Fed abruptly changes course. Investors would do well to ensure that firms like this are not significant holdings in their portfolios.
Chart of the Week
This week’s chart is our final look at earnings for Q4 2021. With most companies having reported, the results are generally quite good. The S&P 500 has posted an average upside surprise of 5.5%, with technology representing the largest average beats. Energy has also done quite well, though. In sum, earnings season has been positive. Coming quarters, however, may be more challenging as rising input costs begin to eat away margins.
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